How To Detect If A Franchisor Is Covering Up Failures. Seasoned Sales Pro Offers Guidance.

All franchise networks lose franchisees, but prospective franchisees should investigate the how and why of these departures.

 

The normal exit patterns

Franchisees leave a franchisor’s network in one of 3 ways:

1. They transfer their license, or re-sell their business. They may sell to a new franchisee, an existing franchisee, or even the franchisor.
2. They willfully terminate their franchise license, or the franchisor terminates it. Many terminations are “mutual” agreements between franchisee and franchisor, and for various reasons. With a “mutual” termination the parties agree to go their separate ways without blaming each other!
3. They do not renew their franchise license after the current term,  or the franchisor decides not to renew it.

How many left the system?

“Before you buy a franchise,” advises Jason Killough, a consultant with  The Entrepreneur Authority (TEA), “it’s important that you know how many franchisees left the system, and why. It’s not always a bad thing that franchisees left the system, but it could be.”

U.S. franchisors are required to disclose the names of all franchisees who left the system whether they transferred, terminated, non-renewed or were bought by the franchisor.

How do you get at this information?

Look at Item 20 of the Franchise Disclosure Document, which the franchisor is required to give you, without obligation or fee.

Look out for net losses

“One number you want to know is how many new franchises did the franchisor sell?” continues Killough. “Hopefully you will see that the franchisor lists more new franchises vs. transfers, terminations and non-renewals. If the franchisor did not have positive net growth, that could be a red flag. It’s especially important in that case to understand why more franchisees left the system than joined.”

How do you get that information?

Three ways:

1. Ask the franchisor. That’s who knows! And the franchisor should be willing to share that information with you. Ask your franchise sales representative for details. If it’s difficult to get this information, or you can’t get it, that’s another red flag.
2. Ask franchisees. They know! They may not know the details, but they know. Ask them why more franchisees left than joined.
3. Ask the franchisees that left the system. Their names and contact information will be included in the FDD. It’s often difficult to get these folks to answer their phones — often times they want to forget a bad memory. Or it may be they agreed not to talk when they mutually terminated. Be persistent about contacting them. Ask other franchisees to help you find them.

Dig deep and find out the reasons

Killough says, “If you see a high number of transfers, be sure to dig deeper to find out why. A franchisee might get an offer he can’t refuse, and that’s a good reason to transfer. Or he may have sold for personal reasons, including a divorce or a death. On the other hand, the franchisee may have transferred because he wasn’t making money, or he was unhappy with the franchisor.”

Always push for explanations, and don’t buy if you don’t feel comfortable.

“Churning” may be the real story

Some franchisors may be “churning” franchises. They aggressively buy back franchises to save a termination, or they find willing buyers, sometimes at a loss to the original franchisee. “From a franchisor’s perspective, transfers (or re-sales) are always better than terminations,” explains Killough. “With a transfer, the franchisor is not decreasing their franchise count. Word of caution: Find out if a franchisor is hiding behind an actual failure by transferring or churning franchises.”

Buying a re-sale may be for you

Sometimes you can get a better deal buying a transfer instead of a new franchise. Plus, you don’t have to start the business from scratch — it already exists. On the other hand, if the previous owner ran down the business and gave it a bad reputation, you may have to spend an inordinate amount of money to revive it, and then still fail. Proceed cautiously.

“Go into your evaluation of a franchise with your eyes wide open,” advises Killough. “The more research you do, the better equipped you will be to make an informed business decision.”

Jason Killough is based in North Texas. Prior to TEA, he sold and supported franchises domestically and internationally for I Can’t Believe It’s Yogurt, Jani-King, ASI Sign Systems, Pizza Inn, 24seven Vending and HomeVestors.