Explanation

The franchisor's audited financial statements reveal significant signs of financial weakness. For the year ending December 31, 2024, Chatime Franchise, LLC (Chatime LLC) reported a net loss of over $561,000 and a Member's Deficit (negative net worth) of over $416,000. Note 4 on liquidity explicitly states reliance on its parent company for funding. This financial position may impact its ability to support you and grow the brand, posing a substantial risk to your investment.

Potential Mitigations

• A franchise accountant should thoroughly analyze the financial statements, including the footnotes and the parent company's ability to provide continued support.
• Discuss the franchisor's specific plans to achieve profitability and financial stability with your business advisor.
• Your attorney should investigate if any financial assurance, such as a performance bond, is required by state regulators due to this financial condition.

Explanation

Item 20 data reveals a high rate of franchisee cessations. In 2022, 6 of 17 franchised outlets at the start of the year ceased operations for other reasons, a rate of over 35%. In 2023, 3 of 16 ceased operations, a rate of nearly 19%. Such a high turnover rate is a significant red flag, potentially indicating systemic problems, franchisee dissatisfaction, or a challenging business model which could affect your potential for success.

Potential Mitigations

• It is critical to contact a significant number of former franchisees from the list in Exhibit G to understand why they left the system.
• Your business advisor should help you question the franchisor about the specific reasons for this high rate of closures.
• An accountant should model a worst-case financial scenario for your pro forma based on this high turnover data.

Explanation

The franchisor is rapidly expanding, with the number of franchised outlets growing from 10 to 16 in 2024. This growth, when combined with the company's significant net loss and negative equity position as shown in Item 21, raises concerns. A franchisor expanding quickly without sufficient financial resources or support infrastructure may struggle to provide adequate training, site selection assistance, and ongoing operational support to all its new franchisees, including you.

Potential Mitigations

• During your calls with existing franchisees, ask specifically about the quality and responsiveness of the support they currently receive.
• A business advisor can help you question the franchisor on their specific plans to scale their support staff and systems to match unit growth.
• Your accountant should review whether the franchisor's cash flow can sustain both growth and franchisee support.

Explanation

Chatime LLC is a wholly-owned subsidiary of Chatime Global LLC, which has a complex ownership structure involving other entities based in Australia and Taiwan. The financial statements provided are for Chatime LLC only, which is operating at a significant loss and relies entirely on its parent for financial support. The lack of financial statements for the ultimate parent companies makes it difficult to fully assess the overall stability and resources backing the brand and the guarantee of support.

Potential Mitigations

• Your accountant must carefully review the liquidity note in the financials that discusses the parent company's commitment to provide financial support.
• It is important to discuss with your attorney the legal enforceability of the parent's promise to fund the US franchisor's operations.
• A business advisor can help you assess the risks associated with this complex international corporate structure and the reliance on foreign entities.

Explanation

Item 3 discloses that the franchisor's affiliates have a history of significant government enforcement actions. Both the New York Attorney General and the Washington Department of Financial Institutions took action against them for selling unregistered franchises. These actions resulted in penalties, costs, and obligations to offer rescission to affected franchisees. This pattern of non-compliance with state franchise laws is a serious red flag regarding the franchisor's historical business and legal practices.

Potential Mitigations

• Your attorney must review the details of these enforcement actions and explain their implications.
• It is wise to ask the franchisor what changes in management or compliance procedures have been implemented to prevent future violations.
• A business advisor should consider this history as a significant risk factor in your overall due diligence.