Investing in a well-established franchise can be a rewarding experience that provides a steady income stream for years, if not decades. However, joining a franchise is still a risky investment. These risks can arise in the normal course of business or due to the misconduct of potentially bad actors who take advantage of unsuspecting investors. Regardless of the franchisor’s intentions, being aware of common franchise red flags can assist you in objectively evaluating franchise opportunities and avoiding bad partnerships.
Inadequate Transparency Regarding the Franchise
While joining a franchise is intended to benefit both parties, the process inherently involves conflicting interests. The franchisor must exercise caution when disclosing potentially valuable information about the operation of the franchise to an uncommitted franchisee. Similarly, a franchisee desires as much information as possible to make an educated choice about the franchise opportunity.
Nonetheless, a franchisee should exercise extreme caution when dealing with a franchisor who is excessively protective of its disclosures to the point where you cannot consider the investment. The Franchise Rule requires franchisors to include certain disclosures in their franchise disclosure documents. An FDD that is out of date, incomplete, or otherwise useless should raise red flags about the franchise. When this occurs, do not be afraid to request additional information and be suspicious of those who withhold information without a reasonable explanation.
Guaranteed Success and Profitability
Another red flag of a franchise is a promise of guaranteed success or earnings that is too good to be true. This point reinforces the notion that all investments involve some level of risk, which means that ensuring business success is nearly impossible. Any prediction regarding the size of the franchise’s earnings or other success metrics is merely that – a prediction.
Such assurances of future outcomes are frequently based on assumptions about past data or other information. Consider information gaps and other distinguishing factors that could question the credibility of guarantees of success (e.g., the promise relies on data from a geographic market entirely different from your franchise opportunity).
Vague Contracts Granting a Franchisor Excessive Discretion
The franchise agreement and other legal documents indicate what owning a franchise will and maybe like. As a franchisee, you are paying a premium to invest in a proven business model and gain access to resources that will help you succeed (e.g., training, IP rights, infrastructure and other trade secrets). Your franchise agreement and other legal documents should specify exactly what you’re purchasing.
Concerned about Franchise Red Flags?
Evaluating a franchise opportunity’s common franchise red flags will always be a business decision made by the investing franchisee. Keeping an eye out for potential red flags in an offering, on the other hand, can help you avoid costly franchise investments in favor of more lucrative opportunities. Working with legal counsel during the evaluation stage may also assist you in identifying red flags and gaining a better understanding of your legal risks when considering a franchise
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