Any significant financial investment warrants careful consideration, and this includes investing in a franchise. With more than 5,000 registered franchise brands in the United States, the importance of due diligence for prospective investors cannot be overstated. With so many companies and industries to choose from, finding the right fit can be daunting. That’s why we put together this guide – to help potential investors structure their research process when choosing a franchise to invest in.
Knowing what you want your investments to help you achieve is the first step in evaluating whether investing in a franchise makes sense for you. After all, you can’t get where you’re going without first being clear on your final destination.
Start with a frank and honest evaluation of your current financial situation and your goals for the future. Ask yourself these questions:
Once you’ve determined where you’d like your investments to take you financially, the next step is to consider your lifestyle goals. Ask yourself questions such as:
If you’re considering investing in a franchise, these types of questions are particularly important since your desired lifestyle will dictate whether traditional franchising is a good fit for you. Becoming a franchisee is easier than starting from scratch with a single-location business, but it is still a time-consuming process. You’re responsible for implementing the management and marketing plans laid out by your franchisor, as well as standard operations such as hiring, personnel management, ordering, and scheduling, among others.
Part of the due diligence process includes getting to know the franchises you’re interested in. There are a few sources you can use to obtain more information about each company.
A conversation with your potential franchisor is a great way to start your due diligence process. Setting up a preliminary call is typically as easy as filling out an online form. This is an opportunity to get a high-level overview of the company and how it runs its franchise program.
Who you’ll end up speaking with will vary depending on the franchise. Some companies have an internal franchise development team, while others outsource this function to specialized franchise development companies (FDCs).
Regardless, some potential questions to ask on these calls include:
As you get to know the team on the other end of the franchise, remember that these conversations serve a dual purpose – not only are you interviewing a potential business partner, but they are interviewing you as well.
The Franchise Disclosure Document (FDD) is a standardized document that must be provided to prospective franchisees and investors by franchisors. Created by the FTC, the FDD facilitates disclosure of critical aspects of each franchise as a business, including the franchisor’s background, a franchisee’s obligations, trademarks, any financing arrangements, and more. This document can help prospective franchise investors answer questions such as:
Each FDD has 23 sections and provides even more detailed information than outlined by the questions above. It should be reviewed carefully by each prospective investor along with their legal counsel.
Once you have the FDD in hand and the franchisor has validated your intentions (i.e., ensured that you’re serious), you’ll likely receive a list of current and past franchisees. You should speak with at least five people from the list to get the best idea of what day-to-day life is like running a franchise. Here are some questions you might ask:
Keep in mind that some franchisees may assume their franchisor is monitoring their conversations with potential investors and may be evasive or noncommittal with certain questions. That’s okay – it tells you something all on its own. Be sure to strike a balance between collecting good information and being respectful.
If the process of answering all the questions we’ve discussed so far seems like a significant time investment, that’s because it is. Investing in a franchise as an individual is not a decision to be taken lightly and can involve an initial outlay of $100,000 or more. With such a significant investment, you cannot afford to cut corners when it comes to research.
But what if there was a better way?
At FranShares, we’ve taken the fractionalized model of investing (previously used for pricey luxuries such as vacation homes and private jets) and applied it to franchises. This approach allows investors from all walks of life to invest in a portfolio of pre-vetted, managed franchises – and do so completely passively.
FranShares pursues every franchise opportunity using a systematic due diligence process. Investment teams evaluate franchise businesses for potential fund inclusion using specific metrics and a meticulous screening process. You can learn more about this topic by reading our blog post, How FranShares Selects Franchises. The bottom line is that we take care of the due diligence so our investors don’t have to.
Our novel investment model comes with additional benefits:
To learn more about how we’re opening the door to a new chapter in wealth-building for our investors, click here to sign up for our mailing list and review our offerings.
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(1) Portfolio IRR projections are calculated using all cash flows, including the initial investment of $25,000,000 of offering proceeds, annual earnings before interest, depreciation and amortization (“EBITDA”), less estimated corporate taxes, and the sale of the entire portfolio at the end of the fifth year at 5x EBITDA.
(2) Cash Yield projections are calculated as the arithmetic mean (average) of five years of annual cash flows (including EBITDA, less estimated corporate taxes) divided by the initial investment of $25,000,000 of offering proceeds.
(3) Equity IRR projections are calculated using the initial investment of $25,000,000 of offering proceeds and the sale of the entire portfolio at the end of the fifth year at 5x EBITDA.