Explanation

Analysis of Item 20 and Exhibit D reveals that five outlets ceased operations under their prior owner in 2024 out of a starting base of 35, representing a 14.3% churn rate for the year. While these were categorized as transfers or mutual cancellations, a high rate of outlets changing hands can indicate underlying issues such as franchisee dissatisfaction or lack of profitability, which may present a risk to the stability of the system.

Potential Mitigations

• It is critical to contact a significant number of current and former franchisees, especially those listed in Exhibit D, to understand why they left the system.
• A franchise attorney can help you formulate appropriate questions for these conversations to better gauge system health.
• Discuss the turnover rate and its potential implications for system stability with your business advisor.

Explanation

The franchisor has grown from 22 to 44 franchised units in two years. While recent financials show improved profitability, the FDD explicitly warns that the franchisor's financial condition may impact its ability to provide support. Rapid growth can strain a franchisor's resources, potentially leading to challenges in providing adequate training, site selection assistance, and ongoing operational support to all franchisees as the system expands.

Potential Mitigations

• Inquire with the franchisor about their plans and budget for scaling support staff and infrastructure to match unit growth.
• Ask a broad range of existing franchisees about their perception of the quality and timeliness of franchisor support.
• Your accountant should review the franchisor's investments in support infrastructure as reflected in the financial statements.

Explanation

The franchisor, Iron Valley Real Estate, LLC (IVRE LLC), was organized in May 2018 and began franchising in September 2018. While its affiliate has operated since 2013, the franchise system itself is relatively young. Younger systems may have less-developed support structures, limited brand recognition, and an unproven long-term track record for franchisee success. The historical financial weakness noted in Item 21 further elevates the risks associated with an emerging franchise brand.

Potential Mitigations

• A business advisor can help you conduct extensive due diligence on the management team’s specific experience in both real estate and franchise system management.
• It's crucial to speak with the earliest franchisees listed in Item 20 to understand the system's evolution and the franchisor's performance.
• Your accountant should carefully assess the franchisor’s capitalization and financial stability, considering its relatively recent start.

Explanation

Item 2 discloses the professional backgrounds of the franchisor's executives. They appear to have significant experience in the real estate industry. However, the franchise system itself was only started in 2018, so the management team's experience in specifically managing a franchise system, as opposed to a company-owned brokerage, is more limited. Risks can arise if a management team is not adept at providing franchisee support.

Potential Mitigations

• Engage a business advisor to help you vet the management team’s specific experience in supporting a franchise network.
• It's wise to speak with multiple franchisees about their direct experiences with the quality of management's guidance and support.
• Ask the franchisor directly about how their past industry experience translates to supporting independent franchise owners.

Explanation

Item 3 discloses two legal actions. First, a 2019 settlement with Virginia regulators for selling an unregistered franchise, resulting in fines. This suggests early compliance issues. Second, a 2024 lawsuit initiated by the franchisor against a former franchisee for breach of contract and defamation, resulting in a default judgment of over $88,000 in the franchisor's favor. While not a pattern of franchisee-initiated fraud claims, this history indicates past regulatory trouble and a willingness to litigate against franchisees.

Potential Mitigations

• A franchise attorney must review the details of the disclosed litigation to assess its implications.
• Discuss the regulatory action with your attorney to understand the nature of the past compliance failure.
• Consider the litigation against a former franchisee in the context of the franchisor's overall relationship with its operators, with input from your business advisor.