Explanation

This risk was not identified in the FDD package. High franchisee turnover, evidenced by a large number of terminations, non-renewals, or re-acquisitions in Item 20, can be a major red flag. It often signals systemic problems such as low franchisee profitability, inadequate support, or a flawed business model. A stable system generally has low turnover, indicating franchisee satisfaction and success.

Potential Mitigations

• To understand system health, having an accountant help you calculate the annual turnover rate from Item 20 data is a valuable step.
• It is always wise to ask a significant number of current and former franchisees about their experiences and satisfaction with the system.
• Consulting a business advisor can help you compare the system's turnover rate with industry averages for context.

Explanation

This risk was not identified in the FDD package. Investing in a new or unproven franchise system carries higher risk because the business model may not be fully tested, brand recognition is minimal, and the franchisor may lack experience in providing franchisee support. A history of successful operations, as shown in Items 1, 20, and 21, provides a better basis for evaluating the opportunity.

Potential Mitigations

• A business advisor can help you investigate the franchisor's and its executives' prior experience in both the specific industry and in managing a franchise system.
• Speaking with the earliest franchisees in a system is crucial for due diligence.
• An accountant should carefully scrutinize the franchisor's capitalization to ensure it can support its initial growth phase.

Explanation

This risk was not identified in the FDD package. A fad business is one tied to a fleeting trend, which can be a significant risk for a long-term investment like a franchise. Once public interest wanes, the business may no longer be viable, but you would still be bound by your franchise agreement. It is important to assess if a business concept has sustained consumer demand and long-term market relevance.

Potential Mitigations

• Your business advisor can help you conduct independent market research to assess the long-term viability and consumer demand for the products or services.
• Investigate the franchisor's commitment to research and development to adapt to changing market trends.
• A financial advisor can help you evaluate the business model's resilience to economic shifts and its sustainability beyond the current trend.

Explanation

This risk was not identified in the FDD package. Franchisor management lacking experience in the specific industry or, more importantly, in managing a franchise system, presents a significant risk. Inexperienced leadership can lead to flawed strategies, weak operational systems, and inadequate franchisee support, despite your payment of fees. Reviewing the executive biographies in Item 2 is a critical step in assessing this risk.

Potential Mitigations

• A business advisor can help you thoroughly vet the backgrounds of the management team listed in Item 2.
• Contacting existing franchisees to ask about the quality of support and management's competence is a crucial due diligence step.
• It is wise to ask if an inexperienced franchisor team has engaged external franchise consultants for guidance.

Explanation

This risk was not identified in the FDD package. A franchisor's predecessor is a former entity from which it acquired its assets. It is important to review any disclosed history of predecessors in Items 1, 3, and 4 for signs of past trouble, such as litigation, bankruptcy, or high franchisee failure rates, as these issues could be inherited by the current franchisor and affect the system's health.

Potential Mitigations

• An attorney should always be engaged to carefully review any disclosures regarding predecessor companies in the FDD.
• If a predecessor is named, it can be valuable to conduct independent online research for news or franchisee complaints related to that entity.
• Asking long-term franchisees about their experience under any previous ownership provides valuable insight.

Explanation

This risk was not identified in the FDD package, as Item 3 discloses no litigation. A pattern of litigation against the franchisor by franchisees, particularly for claims of fraud or misrepresentation, is a critical red flag. Likewise, a high number of lawsuits initiated by the franchisor against its franchisees can suggest an overly aggressive or litigious culture, which can be detrimental to a collaborative franchise relationship.

Potential Mitigations

• Your attorney should always be consulted to analyze any litigation disclosed in Item 3, including the nature of the claims and their outcomes.
• Even if no litigation is disclosed, asking current and former franchisees about disputes within the system can provide valuable informal insights.
• A business advisor can help assess if the disclosed litigation volume is unusual for a system of its size and age.