Explanation

The FDD discloses significant financial risks. Audited financials in Exhibit D show a large and persistent members' deficit (negative net worth), a history of operating losses, and current liabilities that far exceed current assets. Note 9 of the financials explicitly states these factors create uncertainty about financial stability, and the company relies on loans from its majority member to operate. This condition may impact Redline Athletics Franchising, LLC (Redline LLC)'s ability to provide support or meet its obligations.

Potential Mitigations

• An experienced franchise accountant should perform a deep analysis of the franchisor's financials, including cash flow statements and all footnotes.
• Discuss the implications of the company's reliance on member loans for funding with your financial advisor.
• Your attorney should review any state-mandated financial assurances like bonds or fee deferrals that may be required due to this financial condition.

Explanation

A significant discrepancy exists between data sources. While Item 20 tables show only one unit termination over three years, the franchisor's audited financial statements (Exhibit D, Note 1) report 11 unit closures in 2023 alone. This represents a closure rate of approximately 24% of the starting units for that year. Such a high rate is a critical red flag suggesting potential systemic problems or issues with profitability at the unit level.

Potential Mitigations

• It is critical to contact a large number of current and former franchisees from the list in Exhibit F to understand their experiences and reasons for leaving.
• Your accountant must help you reconcile the conflicting information between Item 20 and the audited financials.
• A business advisor can help you assess the potential impact of high unit turnover on your role as a Regional Developer.

Explanation

The franchisor's financial statements show very limited resources and reliance on member loans, while the unit franchise system has a high closure rate. This combination suggests that while growth in the past was managed, the support infrastructure may be strained. Rapidly selling new franchises to offset closures, without the financial capacity to support them, could pose a risk to both new and existing franchisees in your territory.

Potential Mitigations

• Question the franchisor directly about its capacity and plans for scaling support infrastructure with your business advisor.
• Interview a broad range of existing franchisees about the current quality and responsiveness of franchisor support.
• An accountant's review of the franchisor's financials is crucial to assess if they have the resources to properly support the system.

Explanation

Redline LLC was formed in 2013, so it is not a new system in the strictest sense. However, its significant financial instability, reliance on member loans for funding, and the high rate of recent unit closures could present risks similar to those of an unproven or struggling system. These factors may suggest challenges with the long-term viability or profitability of the business model, which can increase risks for Regional Developers and the franchisees they recruit.

Potential Mitigations

• Conduct extensive due diligence on the management team's history and their strategy for achieving stability and profitability with your business advisor.
• Speak to a representative sample of franchisees listed in Item 20 about the system's evolution and the effectiveness of franchisor support.
• Your accountant should project the franchisor’s financial trajectory and assess its capitalization.

Explanation

Item 2 shows that some key executives have been with the franchisor for many years, indicating industry experience. However, one Vice President of Operations is also a franchisee and was a realtor, and another executive's recent prior experience was as a mortgage loan originator. The franchisor's significant financial struggles and high unit closure rate could call into question the management team's effectiveness in operating a stable and profitable franchise system, which is a risk for you.

Potential Mitigations

• Thoroughly vet the management team's specific track record in managing a franchise system of this size and type with your business advisor.
• Discuss management's effectiveness, strategic direction, and responsiveness with a range of current franchisees.
• Inquire about the operational and financial strategies the current management team is implementing to address the disclosed financial instability.