Explanation

The franchisor explicitly warns of its financial condition. Audited financial statements in Exhibit L show a negative net worth of ($104,304) for 2023. While profitable in recent years, profitability depended heavily on one-time PPP loan forgiveness. This financial position may question the franchisor's ability to provide long-term support, invest in the system, or meet its obligations without relying on new franchise sales, which appear to be struggling based on Item 20 data.

Potential Mitigations

• A franchise accountant must conduct a thorough analysis of the audited financial statements, including all footnotes and revenue sources.
• Your business advisor should help you assess whether the company has sufficient capital and stable cash flow to support its obligations.
• Discuss the implications of the negative net worth and reliance on non-recurring income with your attorney.

Explanation

Item 20 data reveals a severe and consistent decline in the number of operating franchises. The system shrank from 10 franchised units at the start of 2021 to only 3 by the end of 2023, a 70% decrease. Additionally, the franchisor notes its intent to terminate another 24 franchise agreements for failure to develop. This extremely high rate of unit closure and failure to open strongly suggests potential systemic issues with the business model, profitability, or franchisor support.

Potential Mitigations

• It is critical to contact former franchisees listed in Exhibit K to understand why they left the system; your attorney can help frame questions.
• Your accountant should analyze the multi-year trends in Item 20 to grasp the full extent of system decline.
• A business advisor can help you assess if the underlying causes of this high turnover could affect your potential for success.

Explanation

The franchisor shows a pattern of signing franchise agreements but failing to get units open, as evidenced by the high number of agreement terminations for unopened outlets noted in Item 20. While the number of operating units is shrinking, the franchisor continues to sell franchises. This pattern, combined with weak financials in Item 21, may suggest that the franchisor's business model could rely more on initial fee collection than on the long-term success and royalty streams of its franchisees.

Potential Mitigations

• Your accountant should carefully analyze the franchisor's revenue streams in Item 21 to determine the dependency on initial fees versus royalties.
• Question the franchisor on their strategy for improving franchisee support and ensuring new units successfully open and operate.
• A business advisor should help you evaluate the risk that your success is secondary to the franchisor's need to sell more franchises.

Explanation

The franchise system began offering franchises in 2016 but has experienced a significant contraction, as shown in Item 20. The combination of a relatively young system with a high failure rate and negative net worth disclosed in Item 21 presents a considerable risk. The business model's long-term viability and the franchisor's ability to provide stable, effective support appear to be in question, increasing the risk for new investors.

Potential Mitigations

• A thorough review of the management team's prior industry and franchising experience described in Item 2 is critical with your business advisor.
• Your accountant must analyze the franchisor's financials in Item 21 to assess its capitalization and ability to weather this period of contraction.
• It is imperative to speak with the few remaining franchisees about their experience and the franchisor's performance.

Explanation

Item 3 discloses pending litigation, including an investigation by the California Department of Financial Protection and Innovation regarding potential violations of franchise law. It also details a recently concluded lawsuit initiated by a franchisee alleging breach of contract and franchise law violations. Although the franchisor prevailed at trial, the case is under appeal. This pattern indicates potential regulatory scrutiny and franchisee disputes, which are significant risk factors for the system's stability and operational integrity.

Potential Mitigations

• Your attorney must carefully review the details of all disclosed litigation and regulatory actions.
• It is advisable to have your attorney assess the potential impact of the California investigation on the franchise system.
• Discuss the nature of these disputes with current and former franchisees to understand the underlying issues from their perspective.