Franchise Due Diligence: Everything That Glitters is Not Gold

Most franchise candidates I work with ask me about due diligence and what it actually means and entails, and especially as it applies to exploring a franchise opportunity.

First, I make certain they actually understand the definition of the term. Defined by Merriam-Webster for business application is the research and analysis of a company or organization done in preparation for a business transaction (such as a corporate merger or purchase of securities).

Of course, entering into a franchise relationship is an example of a business transaction, so it’s easy for a candidate to understand how due diligence applies for them. There never appears to be a doubt in their minds as they nod their heads in affirmation. Yet, sadly, some hardly do any due diligence. That is something that I’ll never understand.

In any event, I also take ample time to discuss what should be done in their due diligence and especially questions they should be asking along the way. In various articles I’ve published, I’ve outlined some of those questions as well as the different things candidates should be doing to fully understand all aspects of the franchise opportunity and what they can expect as a franchisee. After all, everything that glitters is not gold!

Today, let’s look at one of those articles, Exploring a Franchise Opportunity: Do your due diligence… and then some!

Potential franchise buyers must know that before making a final decision, they need to obtain information from other franchisees and also from the franchisor. But what information do they need to secure?

I always recommend using the Franchisor’s Franchise Disclosure Document (FDD) as a guide. I instruct candidates to read through it and ask a potential franchisor very specific questions about each item listed. It’s a can’t miss road map. Plus, it ensures that candidates actually read the document.

What is the history of the franchise concept?

What is the founder’s vision? Who is on the executive and support teams? What experience do these individuals bring to the table? If members of the franchisor team haven’t worked at a location within the franchise system – or any franchise system – how have they learned about daily operations? Have any of them owned a business before? It’s important to understand how these individuals relate to franchisees in the system.

How high could expenses go?

All expenses should be clearly defined. It’s imperative to gain a complete understanding of the range of expenses – and why they are what they are. In today’s post-pandemic era, it’s essential to confirm that costs reflected in the FDD, a document that may have been renewed just six months ago, is frequently checked and updated to reflect real-time costs. Ask about potential increases and delays that may be the result of continuing supply chain and labor issues.

Know what’s happening on the front line.

What is the temperament of the franchise group nationally and within your market or region? Of course, I highly recommend speaking with franchisees, too. Make sure to ask them about costs, problems, profits, and trends. Discuss competition of both the franchisor and franchisees. Ask franchisees their opinions about the culture of the franchise organization and especially when addressing challenges.

Ask about exit strategies.

At some point, you may want to exit the system, or you may have to exit. If you have to exit, is there support if you’re in trouble? Ask about transfer fees and the process of selling your business. Understand the franchisor’s approval process for a potential buyer. What happened to each franchisee listed under terminated or closed franchisees on the FDD? What happened to their locations? Have these locations continued operation under a new franchisee or as corporate location? Is the location still available?

Before making a final decision.

After this process is complete and you’ve reviewed your notes, trust your gut instinct! Take your time and think things through until you’re 100% sure of your decision. Make sure you have all your support mechanisms in place, including friends and family. Do not kid yourself. Do not lie to yourself. And do not justify any negatives. Being honest with yourself will help you make the right decision.

Get your financial house in order.

Franchisors and lenders have certain minimum criteria when it comes to approving franchisee candidates. Some may require a minimum net worth and a certain amount in liquid assets. It would benefit you to set yourself up financially – for example: check your credit score, calculate your debt-to-income ratio, gather your tax returns and other financial documents, and even update your resume. Doing so will also help minimize stress levels!

Don’t underestimate how much funding you will need.

One of the leading causes of small business failure is undercapitalization or insufficient funding. Make sure you have enough of a buffer to help with any unexpected operating costs. What happens if you have underestimated the length of time to positive cash flow and need additional funds? Do you have a plan for that possibility, as well as for unforeseen emergencies?

Talk to a franchise funding professional.

Securing funding can be challenging but is one of the most important steps in starting a business. Knowing your options and ensuring you have a solid funding plan in place is often the key to long-term success and profitability. Get pre-qualified. You do this with a home, why not a business? By getting pre-qualified through a funding provider, you can better identify what you can afford.

One that I highly recommend is Benetrends Financial. They’ve been funding America’s most popular franchise brands for over 35 years. Their innovative, fast and economical suite of funding solutions is designed to help franchisees secure the capital needed to successfully launch a franchise business.

Action Item: Contact Benetrends Financial for a complimentary funding consultation or find out your fundability with their free pre-qualification funding calculator.

Yes, everything that glitters is not gold. If you believe that may not be true, I recommend reading Why You Need To Avoid This Franchise Due Diligence Trap At All Costs by Franchise Ownership Advisor, Joel Libava, The Franchise King. I’m certain it’ll help put an exclamation point on the necessity of performing due diligence… and then some!

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Have a great day. Make it happen. Make it count!