Explanation

Clozetivity Holdings, Inc. (Clozetivity) presents an audited opening day balance sheet showing only $100 in cash. While a note mentions acquiring assets valued over $1M from a predecessor, the company itself appears to be a new, thinly capitalized entity. The FDD's own 'Special Risks' section explicitly states that the franchisor's financial condition 'calls into question the franchisor's financial ability to provide services and support to you.' This poses a significant risk to the company's stability and support capabilities.

Potential Mitigations

• Your accountant must carefully review the franchisor's financial statements and the nature of the asset transfer from the predecessor.
• Discuss the implications of a thinly capitalized franchisor with your franchise attorney, especially regarding its ability to fulfill its obligations.
• A business advisor can help you assess the operational risks associated with a franchisor that may lack sufficient financial resources.

Explanation

Item 20 data reveals a significant level of franchisee turnover. In 2023, the system began with 26 franchised outlets and experienced 9 terminations. This represents a termination rate of nearly 35% of the starting base for that year. Such a high rate of franchisees leaving the system is a critical red flag and may indicate systemic problems, such as issues with the business model's profitability, the quality of franchisor support, or franchisee-franchisor relations.

Potential Mitigations

• It is crucial to contact a significant number of former franchisees listed in Exhibit G to understand their reasons for leaving the system.
• Analyzing the high termination rate and its potential impact on your investment is a key task to perform with your business advisor.
• Your franchise attorney should be consulted to discuss the potential implications of joining a system with this level of turnover.

Explanation

The franchise system has grown very quickly, expanding from 9 to 57 franchised outlets between the start of 2022 and the end of 2023. Such rapid expansion, particularly for a new franchisor entity with limited stated capital, can strain support resources. This may affect the quality and availability of training, operational assistance, and marketing support for all franchisees as the franchisor's infrastructure struggles to keep pace with the number of new units.

Potential Mitigations

• In discussions with current franchisees, specifically inquire about the quality and responsiveness of the support they receive from the franchisor.
• Your business advisor can help you question the franchisor about their plans and capacity for scaling support infrastructure to match this rapid growth.
• Have your accountant review the franchisor's financials in conjunction with the growth data to assess its ability to fund necessary support services.

Explanation

The franchisor, Clozetivity, is a new corporation formed in late 2023 that acquired the assets of a predecessor in March 2024. The FDD explicitly discloses 'Short Operating History' as a special risk. This, combined with the new entity's minimal opening day balance sheet, an extensive history of litigation and regulatory actions tied to the principals and their other brands, and high franchisee turnover under the predecessor, indicates a very high-risk, unproven venture under this new corporate structure.

Potential Mitigations

• Engaging a franchise attorney to conduct deep due diligence on the principals and their entire history of franchise operations is essential.
• Your accountant should perform a thorough analysis of the viability of the business model given the risks associated with a new system.
• A business advisor should help you create conservative financial projections that account for the higher risks of an unproven system.

Explanation

The principals have experience operating other franchise systems, as disclosed in Item 2. However, this experience is significantly offset by the extensive litigation history detailed in Item 3, including multiple franchisee lawsuits alleging fraud and several regulatory actions for non-compliance across their various brands. This pattern raises serious questions about the quality and nature of their management practices, despite their time in the industry. The franchisor's ability to support franchisees effectively appears challenged by these historical issues.

Potential Mitigations

• A thorough review of the principals' complete business history, including the outcomes of all legal and regulatory actions, with your attorney is critical.
• Speaking with franchisees from the principals' other franchise systems could provide valuable insight into their management style and effectiveness.
• Your business advisor can help you weigh their years of experience against the significant history of disputes and compliance issues.

Explanation

The FDD discloses that Clozetivity is a new entity that acquired the assets of a predecessor, Clozetivity Franchising, LLC. The predecessor's history, which is tied to the current principals, includes a significant number of franchisee terminations as shown in Item 20 and is the subject of much of the litigation in Item 3. Understanding this inherited history is crucial, as the operational patterns and management culture from the predecessor are likely to continue with the new entity.

Potential Mitigations

• Your attorney must carefully analyze all information related to the predecessor company in Items 1, 3, and 20.
• Discussing the transition from the predecessor with franchisees who have been with the system through the change is critical.
• Have your accountant evaluate how the predecessor's performance and turnover might reflect on the future prospects of the new company.

Explanation

Item 3 discloses an extensive and concerning pattern of litigation involving the franchisor's principals, predecessor, and affiliated companies. This includes numerous lawsuits from former franchisees alleging fraudulent inducement, as well as multiple regulatory enforcement actions from states like Maryland, Minnesota, and New York for violations of franchise law. The New York addendum also discloses a prior felony conviction for one of the principals. This history suggests a significant risk of disputes and compliance issues.

Potential Mitigations

• A franchise attorney must conduct a thorough review of every litigation and regulatory action disclosed in Item 3.
• It is critical to discuss this litigation history with a significant number of current and former franchisees to understand the context.
• Treating this extensive pattern of franchisee disputes and regulatory sanctions as a major red flag is a necessary conversation to have with your legal and business advisors.