Explanation

The franchisor's audited financial statements show significant revenue and net income for the past three years, with a positive retained earnings balance. Choice Hotels International, Inc. (Choice) is a large, publicly-traded company with substantial assets. The 2024 balance sheet shows a shareholder deficit, which is common for public companies with large treasury stock positions from share buybacks and not necessarily an indicator of financial instability. The auditor's opinion is unqualified.

Potential Mitigations

• Your accountant should review the complete audited financial statements, including all footnotes, to form an independent opinion on the franchisor's financial health.
• It is wise to discuss the nature of the shareholder's deficit and its implications for a public company with your financial advisor.
• Engage your business advisor to assess how the franchisor’s financial strategy might impact franchisee support and brand investment.

Explanation

This risk was not identified in the FDD package. The data in Item 20 indicates that the Rodeway Inn system has been shrinking over the past three years, not growing rapidly. Rapid growth can strain a franchisor's ability to provide adequate support to its franchisees. When a system expands too quickly, resources for training, site selection, and operational assistance can be spread thin, potentially harming franchisee performance and satisfaction across the entire system.

Potential Mitigations

• It is prudent to have your business advisor analyze the system's growth trajectory and compare it against the franchisor's support infrastructure.
• Discussions with franchisees who joined at different times can provide your business advisor with insights into the consistency of franchisor support.
• Your accountant can review the franchisor's financial statements to assess if they are reinvesting sufficiently to support their existing franchisees.

Explanation

This risk was not identified. Choice has operated for decades, beginning in 1939, and is one of the largest hotel franchisors in the world. An unproven system presents higher risks because its business model, brand recognition, and support structures have not been tested over time. New franchisors may have a greater likelihood of failure, may rely heavily on initial franchise fees for survival, and may not have refined their operational or marketing strategies.

Potential Mitigations

• When evaluating any franchise, your attorney should review the franchisor’s history and experience as detailed in Item 1.
• For a new system, your accountant would need to scrutinize the financials for adequate capitalization and sustainable revenue sources.
• A business advisor can help you assess the long-term viability of any new or unproven business model.

Explanation

This risk was not identified. The economy hotel segment is a well-established part of the lodging industry and is not considered a fad. A 'fad' business is one that enjoys rapid, short-lived popularity, which can be risky for a franchisee. When consumer interest wanes, the business may no longer be viable, but you would still be bound by the long-term franchise agreement, including the obligation to pay royalties on declining revenue.

Potential Mitigations

• Your business advisor can help you conduct independent market research to assess the long-term consumer demand for any franchise concept.
• It's wise to evaluate a franchisor’s commitment to research and development to see how they plan to adapt to changing market tastes.
• A financial advisor can help model the business's potential performance under various market scenarios, including waning consumer interest.

Explanation

This risk was not identified in the FDD package. The executive biographies in Item 2 show a management team with extensive and long-term experience in the hospitality and franchise industries. Inexperienced management can be a significant risk, as they may lack the expertise to provide effective support, make sound strategic decisions, or manage the complexities of a large franchise system. This can lead to inadequate training, poor marketing, and a higher risk of system-wide problems.

Potential Mitigations

• Your business advisor should always help you vet the experience of the key executives listed in Item 2 of any FDD.
• Speaking with current franchisees is an effective way to gauge the competence and responsiveness of the franchisor's management team.
• Your attorney can investigate the backgrounds of key personnel to confirm the experience claimed in the FDD.

Explanation

This risk was not identified. Choice is a publicly-traded company, not one primarily controlled by a private equity firm. Private equity ownership can sometimes introduce risks related to a focus on short-term profitability over the long-term health of the brand. This can manifest as cuts in franchisee support, increases in fees, or a quick sale of the franchise system, which could lead to a change in management and operational philosophy that may not be favorable to you.

Potential Mitigations

• It is important to understand the ownership structure of any franchisor, which your attorney can help determine from Item 1.
• If a franchisor is PE-owned, a business advisor can help you research the firm's history with other franchise brands.
• Engaging with franchisees who have experience with PE ownership transitions can provide valuable insight.

Explanation

This risk was not identified. Choice is the parent company, and its financial statements are provided as required. In some franchise systems, a thinly capitalized subsidiary acts as the franchisor, but its more financially substantial parent company is not disclosed or its financials are not provided. This can obscure the true financial health and stability of the entity that is ultimately responsible for supporting the franchise system, creating a significant risk for the franchisee.

Potential Mitigations

• Your attorney should always verify the corporate structure described in Item 1 to ensure all relevant parent and affiliate entities are disclosed.
• If a parent company guarantees the franchisor's obligations, your accountant must insist on reviewing the parent's financial statements.
• Understanding the legal and financial relationship between a franchisor and its parent is a key part of due diligence.

Explanation

This risk was not identified. The FDD provides a clear corporate history dating back to 1939. When a franchisor has acquired a system from a predecessor, it is important to understand that predecessor's history. Negative information, such as high failure rates or litigation under the previous owner, may not be prominently featured. A lack of transparency about a predecessor's track record can hide systemic problems that you may inherit as a new franchisee.

Potential Mitigations

• Your attorney should carefully review any predecessor disclosures in Items 1, 3, and 4 of the FDD.
• A business advisor can assist in researching a predecessor's public reputation and history, if applicable.
• Speaking with long-term franchisees who operated under a predecessor provides invaluable firsthand insight.