Part 3: Current and Former Franchisees

The disclosure document provides important information about current and former franchisees. Determine how many franchises are currently operating; a large number of franchisees in your area may mean increased competition. Pay attention to the number of terminated franchisees; a large number of terminated, canceled, or non-renewed franchises may indicate problems. Be aware that some companies may try to conceal the number of failed franchisees by repurchasing failed outlets and then listing them as company-owned outlets. If you buy an existing outlet, ask the franchiser how many owners operated that outlet and over what period of time. A number of different owners over a short period of time may indicate that the location is not a profitable one or that the franchiser has not supported that outlet with promised services.

The disclosure document gives you the names and addresses of current franchisees who have left the system within the last year. Speaking with current and former franchisees is probably the most reliable way to verify the franchiser's claims. Visit or phone as many of the current and former franchisees as possible; ask them about their experiences. See for yourself the volume and type of business being done.

The following checklist will help you ask current and former franchisees such questions as:

• How long has the franchisee operated the franchise?
• Where is the franchise located?
• What was their total investment?
• Were there any hidden or unexpected costs?
• How long did it take them to cover operating costs and earn a reasonable income?
• Are they satisfied with the cost, delivery, and quality of the goods or services sold?
• What were their backgrounds prior to becoming a franchisee?
• Was the franchiser's training adequate?
• What ongoing assistance does the franchiser provide?
• Are they satisfied with the franchiser's advertising program?
• Does the franchiser fulfill its contractual obligations?
• Would the franchisee invest in another outlet?
• Would the franchisee recommend the investment to someone with your goals, income requirements, and background?

Be aware that some franchisers may give you a separate reference list of selected franchisees to contact. Be careful. Those on the list may be individuals who are paid by the franchiser to give a good opinion of the company.

Earnings Potential

You may want to know how much money you can make if you invest in a particular franchise system. Be careful; earnings projections can be misleading. Insist upon written substantiation for any earnings projections or suggestions about your potential income or sales.

Franchisers are not required to make earnings claims, but if they do, the FTC's Franchise Rule requires franchisers to have a reasonable basis for these claims and to provide you with a document that substantiates them. This substantiation includes the bases and assumptions upon which these claims are made. Make sure you get and review the earnings claims document. Consider the following in reviewing any earnings claims.

• Sample Size. A franchiser may claim that franchisees in its system earned, for example, $50,000 last year. This claim may be deceptive, however, if only a few franchisees earned that income and it does not represent the typical earnings of franchisees. Ask how many franchisees were included in the number.
  
• Average Incomes. A franchiser may claim that the franchisees in its system earn an average income of, for example, $75,000 a year. Average figures like this tell you very little about how each individual franchisee performs. Remember, a few very successful franchisees can inflate the average. An average figure may make the overall franchise system look more successful than it actually is.
  
• Gross Sales. Some franchisers provide figures for the gross sales revenues of their franchisees. These figures, however, do not tell you anything about the franchisees' actual costs or profits. An outlet with a high gross sales revenue on paper actually may be losing money because of high overhead, rent, and other expenses.
  
• Net Profits. Franchisers often do not have data on the net profits of their franchisees. If you do receive net profit statements, ask whether they provide information about company-owned outlets. Company-owned outlets might have lower costs because they can buy equipment, inventory, and other items in larger quantities, or may own, rather than lease, their property.
  
• Geographic Relevance. Earnings may vary in different parts of the country. An ice cream store franchise in a southern state, such as Florida, may expect to earn more income than a similar franchise in a northern state, such as Minnesota. If you hear that a franchisee earned a particular income, ask where that franchisee is located.
  
• Franchisee's Background. Keep in mind that franchisees have varying levels of skills and educational backgrounds. Franchisees with advanced technical or business backgrounds can succeed in instances where more typical franchisees cannot. The success of some franchisees is no guarantee that you will be equally successful.

Financial History

The disclosure document provides you with important information about the company's financial status, including audited financial statements. Be aware that investing in a financially unstable franchiser is a significant risk; the company may go out of business or into bankruptcy after you have invested your money.

Hire a lawyer or an accountant to review the franchiser's financial statements. Do not attempt to extract this important information from the disclosure document unless you have considerable background in these matters. Your lawyer or accountant can help you understand the following.

Does the franchiser have steady growth?

Does the franchiser have a growth plan?

Does the franchiser make most of its income from the sale of franchises or from continuing royalties?

Does the franchiser devote sufficient funds to support its franchise system?

Additional Sources of Information

Before you invest in a franchise system, investigate the franchiser thoroughly. In addition to reading the company's disclosure document and speaking with current and former franchisees, you should speak with the following:

Lawyer and Accountant

Investing in a franchise is costly. An accountant can help you understand the company's financial statements, develop a business plan, and assess any earnings projections and the assumptions upon which they are based. They can also help you pick a franchise system that is best suited to your investment resources and your goals.

Franchise contracts are usually long and complex. A contract problem that arises after you have signed may be impossible or very expensive to fix. A lawyer will help you to understand your obligations under the contract, so you will not be surprised later. Choose a lawyer who is experienced in franchise matters. It is best to rely upon your own lawyer or accountant rather than those of the franchiser.

Banks and Other Financial Institutions

These organizations may provide an unbiased view of the franchise opportunity you are considering. Your banker should be able to get a Dun and Bradstreet report or similar reports on the franchiser.

Better Business Bureau

Check with the local Better Business Bureau (BBB) in the cities where the franchiser has its headquarters. Ask if any consumers have complained about the company's products, services, or personnel.

Government Departments

Several states regulate the sale of franchises. Check with your state Division of Securities or Office of Attorney General for more information about your rights as a franchise owner in your state.

Federal Trade Commission (FTC)

The FTC publishes other information that may be of interest to you, including business guides like Getting Business Credit and Buying by Phone. The FTC works for the consumer to prevent fraudulent, deceptive, and unfair business practices in the marketplace and to provide information to help consumers spot, stop, and avoid them.

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