How Do I Conduct Due Diligence On A Franchise?

Posted on December 1, 2024 by mboxerman

So, you’re thinking about buying a franchise? Franchising can be a fantastic way to dive into business ownership, providing the security of an established brand and proven business model. Before you take the plunge, however, it’s crucial to do your homework and conduct thorough due diligence. This process involves researching and analyzing the franchise opportunity to ensure you know exactly what you’re getting into.

Let’s walk through the steps of due diligence to help you make an informed decision before buying a franchise.

Understand the Franchise Model

First, you need to grasp the franchise model. Start by reviewing the Franchise Disclosure Document (FDD), which contains essential information about the franchisor, including financial health, legal obligations, and fees. Don’t skim this document—read it carefully and seek legal advice to ensure you understand your rights and responsibilities as a franchisee. Along with the FDD, closely review the Franchise Agreement. This contract governs your relationship with the franchisor, detailing fees, territory rights, advertising, and renewal terms. Pay special attention to earnings claims found in Item 19 of the FDD and verify them with existing franchisees.

Research the Franchisor’s History

Next, dig into the franchisor’s history. How long have they been in business? How many franchises and company-owned locations do they operate? Examine their financial statements in the FDD to ensure they are profitable. If the franchisor is struggling financially, it could be a red flag. Also, check for any involvement in litigation or bankruptcy, as these could signal potential risks.

Speak with Current and Former Franchisees

One of the best ways to understand the franchise is by speaking with those who have firsthand experience. Talk to current franchisees about their experiences, profitability timelines, and the support they receive from the franchisor. Ask if they would invest again and what challenges they have faced. Former franchisees can provide insights into why they left, highlighting any potential issues with the franchise.

Assess the Market and Competition

Market conditions can make or break a franchise. Even a successful brand may struggle in the wrong location. Research your local market to determine if there is demand for the franchise. Study your competition to ensure your franchise will stand out. Additionally, confirm whether your contract provides territorial rights, protecting you from nearby competitors opening similar franchises.

Evaluate Costs and Financial Projections

Understanding the financial aspects of a franchise is key. Review the initial investment requirements in Item 7 of the FDD, and ensure you have a cushion for additional expenses like marketing and operational costs during the startup phase. Be aware of recurring fees such as royalties and advertising costs, which you’ll need to cover even if your profits are slim at first. Consult a financial advisor to project cash flow and set realistic profitability expectations.

Franchise Support System

Support from the franchisor is a crucial benefit of buying a franchise. Investigate the level of training and ongoing support provided by the franchisor. Does the franchisor offer assistance with marketing, operations, or supply chain management? Make sure the support system is strong enough to help you succeed.

Understand Legal and Regulatory Obligations

Every business, including franchises, operates under specific legal and regulatory requirements. Before signing any agreements, familiarize yourself with local zoning laws, health regulations, and other relevant legalities. Consulting a franchise attorney is essential to ensure that there are no hidden legal issues in the FDD or Franchise Agreement.

Franchise Territory and Growth Potential

Consider the long-term growth potential of the franchise. Does the franchisor offer expansion opportunities? Ensure that your contract defines your territory rights clearly and assesses whether exclusivity will benefit your business.

Renewal, Transfer, and Exit Strategy

It’s essential to have a plan for the future. Understand the renewal terms of the franchise agreement and whether they are fair. Look into the process for transferring or selling the franchise and whether the franchisor has rights that could complicate these actions. Planning your exit strategy is just as important as planning your entry into the business.

Self-Assessment: Are You Ready?

Before committing, take a moment for personal and financial reflection. Do you have the skills, passion, and financial stability to run the franchise successfully? Consider your tolerance for risk, as franchising, like any business, comes with potential ups and downs.

Conclusion

Conducting due diligence is more than a task—it’s your safety net when buying a franchise. Thoroughly researching all aspects of the franchise ensures that your investment aligns with your financial goals and long-term aspirations. With careful planning and informed decision-making, franchising can be a profitable and rewarding venture.

For help in buying a franchise, contact the attorneys at Marcus & Boxerman at firm@marcusboxeman.com.

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What is a Franchise Disclosure Document (FDD)?

Posted on November 26, 2024 by mboxerman

What is an FDD?

A Franchise Disclosure Document (FDD) is a critical legal document that franchisors are required to provide to potential franchisees before any sale or offer of sale. Mandated by the Federal Trade Commission (FTC) and various state franchise laws, the FDD is a comprehensive informational guide that provides potential franchise owners with crucial details about the franchise opportunity.

Purpose of the FDD

The primary purpose of the Franchise Disclosure Document is to protect potential franchisees by ensuring they receive clear, consistent, and detailed information about the franchise business. It helps prospective franchisees make informed decisions by providing transparent insights into the franchise’s operations, financial expectations, and legal obligations.

Key Components of an FDD

The FDD is organized into 23 items, each covering a specific aspect of the franchise. The document begins with the franchisor’s business background, offering insights into the company’s history and the professional experiences of its key executives. This section provides potential franchisees with a comprehensive understanding of the organization’s roots and leadership.

The document then delves into the franchisor’s legal and financial history. It discloses litigation history, revealing current or past legal actions involving the franchisor. It also provides information about any bankruptcy filings by the franchisor or its key executives, aiming to provide transparency about the company’s and its key executives’ financial stability.

Financial details form a crucial part of the FDD. The document breaks down all initial and ongoing fees, including the initial franchise fee, royalty structures, and advertising fund contributions. A comprehensive estimated initial investment section outlines the expected startup costs, providing a range of expenses from the lowest to the highest possible estimates.

The FDD also details the operational aspects of the franchise. It outlines restrictions on product and service sources, specifying required suppliers and any limitations on where franchisees can purchase supplies. The franchisee’s obligations are clearly articulated, including a detailed list of operational requirements and contractual responsibilities.

Potential franchisees will find valuable information about the support they can expect. The document describes the franchisor’s assistance and training programs, including initial and ongoing training opportunities and support services. Territory information is also provided, clarifying exclusive or non-exclusive territories and any geographical restrictions.

Intellectual property is another critical component. The FDD discloses details about trademark ownership, usage rights, and restrictions. It also provides information about patents, copyrights, and other proprietary information, including any licensing arrangements.

The document includes financial statements and a comprehensive list of current and former franchisees. It concludes with an acknowledgment of receipt form, which the potential franchisee signs to confirm they have received and reviewed the document.

Why the FDD Matters

The Franchise Disclosure Document is more than just a legal requirement—it’s a critical tool for due diligence and risk assessment. It provides potential franchisees with a comprehensive understanding of the full scope of a franchise opportunity, allowing for informed decision-making.

How to Use the FDD

Careful and thorough review is essential when examining an FDD. Potential franchisees should read the entire document meticulously, paying special attention to financial projections and legal obligations. The document should serve as a conversation starter with the franchisor, prompting potential franchisees to seek clarification on any unclear points.

It is highly recommended that individuals consult a lawyer when reviewing an FDD. A franchise lawyer can provide invaluable insights, helping to interpret the legal nuances of the document and to advise you as to what is missing from the FDD. Similarly, a financial advisor can offer expert analysis of the financial projections and potential risks.

Conclusion

The Franchise Disclosure Document is an essential tool for anyone considering purchasing a franchise. It provides a comprehensive, transparent view of the franchise opportunity, helping potential franchisees make informed decisions.

Remember: While the FDD is intended to provide crucial information, it’s just one part of your due diligence. Always conduct thorough research, seek professional advice, and carefully evaluate the opportunity before making a commitment.

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Should I Hire an Attorney to Review My Franchise Disclosure Document (FDD)?

Posted on November 24, 2024 by mboxerman

Considering a franchise investment? Understanding your Franchise Disclosure Document (FDD) is crucial, and professional legal guidance offers significant advantages. Let’s explore the compelling reasons to engage a franchise attorney for your FDD review.

Experienced Navigation of Complex Documentation

The FDD contains 23 distinct sections spanning hundreds of pages. An experienced franchise attorneys can help you understand critical obligations that could impact your business for years to come. This knowledge can be invaluable when navigating through this comprehensive document that governs your entire franchise relationship.

Protection of Your Financial Investment

A professional legal review represents a small fraction of your total investment while providing essential protection against costly oversights. This relatively modest investment can prevent significant financial mistakes and protect your substantial franchise investment.

Identification of Critical Contract Elements

Experienced franchise attorneys can spot crucial details that might otherwise go unnoticed. They carefully examine territory rights and potential encroachment issues, uncover hidden or unexpected fee structures that could impact your profitability. Their review encompasses termination clauses, renewal terms, and transfer restrictions that could affect your business flexibility and long-term success.

Risk Mitigation and Industry Standards

Legal review helps identify potential risks before they become problems. Experienced franchise attorneys can recognize red flags in various areas, including financial obligations, operational procedures, advertising requirements, supply chain limitations, and training commitments. Their extensive experience reviewing FDDs provides unique insight into standard industry practices, unusual provisions, negotiable terms, and current market conditions.

Understanding Long-term Commitments

Your attorney will help you understand the full scope of your long-term obligations. This includes careful examination of agreement duration, renewal conditions, post-termination restrictions, and ongoing financial commitments. This comprehensive understanding proves crucial for long-term business planning and success.

Professional Negotiation Support and Compliance

While many franchise terms are non-negotiable, experienced attorneys can identify areas where negotiation might be possible and guide these discussions effectively. They ensure you comprehend all compliance requirements, including operational standards, reporting obligations, quality control measures, and brand protection requirements. This guidance proves invaluable throughout your franchise relationship.

Peace of Mind and Problem Prevention

Professional legal review provides confidence in your investment decision through clear understanding of obligations and awareness of potential challenges. Early legal review often prevents future disputes by ensuring complete comprehension of performance requirements, default conditions, and dispute resolution procedures. This thorough understanding helps avoid costly misunderstandings and conflicts.

Time and Resource Efficiency

Professional review typically proves more efficient than self-review, allowing you to focus on business planning and avoid common pitfalls. The expertise provided helps you make informed decisions quickly and proceed with confidence, knowing you understand your rights and responsibilities fully.

Moving Forward with Your Franchise Investment

To maximize the benefits of legal review, it’s essential to engage an attorney experienced in franchise law before making any commitments. Take time to prepare specific questions about your concerns and consider the review an investment in your success. Remember that this professional guidance helps ensure you fully understand your rights and obligations before making a significant financial commitment.

The decision to invest in legal review of your FDD represents a crucial step in franchise due diligence. By working with an experienced franchise attorney, you gain valuable insights into your potential investment and protect your interests throughout the franchise relationship. This professional partnership helps establish a strong foundation for your franchise business venture.

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Can an LLC receive S corp. tax status?

Posted on January 29, 2016 by mboxerman

Business owners should keep in mind that LLCs can request S corp. tax status.  This allows your company to remain an LLC for legal purposes but gain the tax benefits of an S corp.  To gain S corp. status, an LLC must comply with the S corp. ownership rules but need not follow corporate formalities.  So, an LLC with S corp. tax status still has more flexibility than a traditional S corp.

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What are the benefits of an S corp.?

Posted on January 29, 2016 by mboxerman

When business owners choose an S corp., it’s for the tax benefits.  S corps. are more rigid and require more paperwork than LLCs, but they pay significantly less in employment taxes, which makes a big difference for highly profitable businesses.  S corps. are beneficial because they:

  • Only pay employment tax for employee wages, not their entire net income;
  • Can write off certain employee/shareholder benefits for more savings;
  • Exist in perpetuity, making it easier to continue operating if a shareholders dies, sells his or her shares, or leaves the corporation;
  • Have clearer lines between the business entity and its shareholders;
  • Seem more legitimate to investors, who view the corporate structure as more stable; and
  • The paperwork resulting from required corporate formalities serves as great evidence of prudent business decisions in the event of a lawsuit

The downsides to S corps. are the restrictions, which include limitations on membership, investments, and types of stock.  S corps. must be managed by a board of directors, not the shareholders, and are required to observe corporate formalities.  If an S corp. fails to meet all of its entity requirements, it converts to a C corp. and loses its tax benefits.

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What are the benefits of an LLC?

Posted on January 29, 2016 by mboxerman

The title “limited liability  corporation” sounds good to business owners, but what are the key benefits of an LLC?  The main reasons business owners choose LLCs over S corps. are simplicity and flexibility.  S corps. are subject to a number of strict requirements while LLCs are more relaxed, leaving you with more room to decide how to run your business.  LLCs are beneficial because they:

  • Have almost no membership restrictions;
  • May be managed by members or selected managers;
  • Do not require corporate formalities, though some are suggested;
  • Can generally make tax-free distributions of appreciated property;
  • Can make member-level tax adjustments for LLC liabilities;
  • Can allocate tax benefits related to depreciation and losses without regard to members’ proportional ownership interests; and
  • Provide greater protection in the event of a personal judgment against a member.
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What do LLCs and S corps. have in common?

Posted on January 29, 2016 by mboxerman

Two key benefits offered by LLCs and S corps. are limited liability and “pass-through” taxation.  Limited liability means that owners generally are not personally liable for the debts and liabilities of the business.  “Pass-through” taxation allows these business entities to avoid double taxation—neither LLCs nor S corps. pay corporate-level taxes.  Instead, all profits and losses are passed through to the business owners and applicable taxes are paid on their individual returns.

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What is joint employment and does it apply to my business?

Posted on January 29, 2016 by mboxerman

The National Labor Relations Board considers franchisors joint employers of their franchisees’ employees when they “share or codetermine those matters governing the essential terms and conditions of employment,” such as hiring, firing, discipline, supervision and direction, determining wages and benefits, setting work hours, and ongoing training of franchise employees.  This is a problem for franchisors because joint employment creates joint liability.

To avoid entering a joint employment relationship, franchisors should:

  • Clearly define the franchisor/franchisee paradigm in franchise agreements by plainly stating that the franchisees alone are responsible for decisions related to personnel matters.
  • Maintain a separation of powers with franchisees.
  • Refrain from directing or attempting to give guidance directly to franchisees’ employees during audits.
  • Make sure franchisees post clear notice, visible to both customers and employees, identifying the location as an independently owned and operated business.

For more information on any of the subjects addressed in our FAQ or employment law in general, contact us at (312) 216-2720 or info@marcusboxerman.com.

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Are my workers employees or independent contractors?

Posted on January 29, 2016 by mboxerman

Knowing whether your workers are employees or independent contractors is crucial for compliance with wage and hour laws and figuring it out is not always as simple as employers think.

“Independent contractor” is the most common misclassification for employees. Employers are tempted to use this classification for workers because independent contractors are not subject to the usual requirements for minimum wage, overtime payments, unemployment insurance, and worker’s compensation benefits.  However, the Department of Labor has found that the vast majority of workers are employees regardless of how agreements between the employer and worker describe the relationship.

The Department of Labor using the “economic realities” test, looking to several factors to determine whether a worker is economically dependent on the business (an employee) or economically independent (an independent contractor).  Those factors include:

  • Whether the work performed is an integral part of the putative employer’s business;
  • Whether the worker’s opportunity for profit or loss depends on his or her managerial skill;
  • How the investment of the worker compares to that of the putative employer;
  • Whether the work performed requires special skills and initiative;
  • Whether the relationship between the worker and employer is permanent or temporary;
  • How much control the employer exerts over the worker.
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What are the best practices for employee termination?

Posted on January 29, 2016 by mboxerman

When you are considering an employee termination, look to applicable employment contracts, your employee handbook, and the employee’s personnel file to find the information you need.  Illinois is an at-will employment state, but employment contracts and the disciplinary practices in your handbook may restrict your ability to terminate without cause.

The employee’s personnel file should contain documentation of all performance and misconduct issues.  Make sure that your employee received an adequate warning that their misconduct could result in termination and that you have sufficient documentation to support your termination decision if the employee decides to take you to court.  If there is not enough supporting documentation, consider whether a different disciplinary action is appropriate.

If you choose to move forward with the termination, offer your employee a severance package in exchange for a release of claims.  By paying a little extra now, you can avoid lawsuits down the line.

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