Pre-Investment Due Diligence - Information You Can Trust

| 0 Comments | 0 TrackBacks

The franchise industry has for years struggled with financial performance disclosures (Item 19 of the FDD). Some claimed not to give such information at all. Many of those simply arranged for franchise investors to get financial performance information from third parties - usually a subterfuge to avoid fraud claims when the truth came out later on. Others give scanty information that looks good to a novice but in reality is just nonsense. Others have loan brokers insert phony pro forma financial information into the franchise investor's business plan in order to impress a startup lender.

The net result of all this shabby history is that franchisees cannot believe any financial performance information provided by a franchisor or anyone acting with or in any connection to the franchisor. The information is so bad that the franchise agreements themselves provide that none was given or authorized, and that any was received by the investing franchisee, he did not rely on it in making his decision to buy the franchise.

The franchisor bar holds seminars every year that include presentations about how to dance around giving financial information and how to trap a recipient of it through the use of dodgy contract provisions.

Accept that what you get from a franchisor you are thinking of buying a franchise from is unlikely to provide financial performance information that you should rely on. Take what they offer to compare against the information you find on your own as you investigate further.


If you are thinking of buying a new start up franchise deal where you take all the start up risks, you owe it to yourself to consider the possibility of buying and existing franchise up for resale. Frankly you would be a fool if you failed to investigate resales of existing franchises of this franchisor or in the industry generally.

No one should ever think of investing in a new franchise without going into this resale aftermarket, so to speak, and seeing what the financial picture really is for people who have gone before you.

You would not be misrepresenting yourself by contacting business brokers and telling them you are looking at such and such franchise and that you want to compare buying a start up against buying a resale. In fact you would be more respected for having done this.

There are many business brokers on the Internet. Just search for business resale brokers, agents, business resales.

Obviously you are looking at a particular geographic area, so start there. If you find nothing in that locale, broaden your search. Location is not as important at first as finding the number of them for sale. Find the ones for sale and arrange to be able to research their financial history. A franchisor claiming his is as good as sliced bread needs to be considered in light of his Item 20 and 21 as well as the resale profiles you find on the Internet.

NEVER EVER RELY ON PROFIT AND LOSS STATEMENTS AND BALANCE SHEETS! You must insist upon three to five years of tax returns. Tax returns are filed under penalty of perjury. No one ever overstates his profits on his tax returns. You will have to sign a nondisclosure agreement, but you do not pay money to see tax returns. You also get to show them to your lawyer and accountant. If anyone tells you otherwise, walk away. Refusal to show tax returns usually means that the seller's profit-loss statements are pure fiction prepared for fools.

In most instances you will find resales. When you review the tax returns for 3 to 5 years you will see (be able to derive) magnitudes of profitability and TRENDS. Declining sales/net profit will tell you the truer story. Certain deductions may need to be assessed back into net revenue - your accountant can tell you that. Interest on debt (to someone other than the owner) may impact several financial questions - especially computing the interest rate being paid against current market interest rates. Paying higher interest rates may be a function of business strength or lack thereof, or bad credit. Sound businesses pay their bills unless they are run by people who fly close to the ground, in which instance you don't want to buy from them. Their payment history with vendors will follow you at least for a while.

When you have built up a significant sized file on what these franchises are really doing and what they are really worth, compare that against what the franchisor or someone working with the franchisor may have told you. If there is more than a minor difference, run like hell.

Smart people verify business representations in making investment decisions. Fools get incinerated.

Leave a comment