The Importance of Due Diligence When You Buy a Franchise

What is Due Diligence?

Due diligence, which is originally coined in reference to the Securities Act of 1993 of the United States, is a legal term that has taken a more legal meaning for the last seventy years. After the stock market crash of 1929, brokers were obliged to follow detailed steps before they can sell securities such as bonds and stocks to investors. Among the causes of the Great Depression was the lack of proper control on Wall Street but now, a lot of things have changed. The concept of due diligence today can be summed up by the phrase, "Do your homework."

Due Diligence as Applied to Franchises

If you're considering buying a franchise, the due diligence part of the decision-making process is considered most important. The franchisor is required by federal and state laws to provide specific documents to prospective franchisees. However, these are not the only evidence you need to examine. There are other elements that require thorough analyses that are beyond what the parent company provides. Below you will find the due diligence checklist that you need to look into when buying a franchise.

The Due Diligence Process

* Examine your expenses. You need to compare the franchise cost and the amount you can afford to pay. If you need more funds, determine as soon as possible where you will acquire them, whether from a bank or a lending institution.

* Study the market. Examine your prospect business and how well the other franchisees operate in the same field. Remember that it is best to look not only at the franchisees of the same business, but also at its competitors. If you notice a decline or stagnant demand in the entire industry, this could be a sign of trouble.

* Compare other opportunities. Look for a franchise that is related to your interests and skills. To start off, find the industry in which you would be comfortable with. Narrow down the industries (such as wholesale, retail, work from home, or mobile) to the ones that you have knowledge about in terms of operational methods, and then compare franchises within these parameters.

* Check training and corporate assistance. All franchisors are required to provide their franchisees with ongoing comprehensive training and field support. Some take these more seriously than others. For a small business, one-week training is enough to learn all the things you need to know. For a complex business, on the other hand, one-week training can barely cover basic information regarding the business.

* Check out other franchisees. Before you buy a franchise, you need to check other existing franchisees by visiting their locations. The franchisees can give you very useful information regarding your prospect franchise business. Almost all franchisees are willing to tell you information that the parent companies won't openly share with you. Their opinions and feedback can serve as great indicators whether you should or should not buy the franchise.

* Examine and understand all documents. A franchisor is required by law to provide necessary legal materials to all prospective buyers. These written materials should be closely examined, from the signatures appearing on the documents to the money involved. The Uniform Franchise Offering Circular or UFOC describes in detail the franchise system, the number of franchise locations that are fully operational, as well as profit and loss statements of the parent company's financial health.

* The franchise agreement will include all the rules and rights enforced on all franchisees who are members of the system. If you find it hard to understand the terms and provisions stated in the documents, you may hire an experienced business attorney to help you go through the legalities.