Explanation

Row House Franchising LLC (Row House) is a new entity with no financial history. It relies on a guaranty from an affiliate, Purvelo Franchising, LLC. The auditor's report for Purvelo includes a 'Substantial Doubt About the Company's Ability to Continue as a Going Concern' note, citing recurring losses and negative cash flow. This is a critical risk, suggesting the entity financially backing your franchise may be unable to provide support or fulfill its obligations, jeopardizing the entire system.

Potential Mitigations

• Your accountant must conduct a thorough review of the guarantor's audited financial statements, paying close attention to the 'going concern' note and its implications.
• It is crucial to discuss the franchisor's financial stability and the guarantor's health with both current and former franchisees.
• Seeking advice from your franchise attorney regarding the strength and enforceability of the affiliate's guaranty is essential.

Explanation

The FDD discloses an extremely high rate of franchisee turnover. In 2023, the system started with 81 franchised units and saw 35 units either cease operations or get reacquired by the franchisor, a churn rate of over 43%. Such a high number is a major red flag and strongly indicates potential systemic problems within the business model, a lack of franchisee profitability, or significant franchisee dissatisfaction. The franchisor explicitly lists 'Turnover Rate' as a special risk.

Potential Mitigations

• It is imperative to contact a significant number of former franchisees from the list in Exhibit J to understand why they left the system.
• Your accountant should carefully analyze the multi-year trends in Item 20 to assess the system's stability and failure rate.
• A business advisor can help you weigh the significant risks implied by such high turnover against any potential rewards.

Explanation

Row House is a brand-new legal entity, formed in May 2024, and explicitly discloses its 'Short Operating History' as a special risk. While the brand has existed under predecessors, you are contracting with an unproven entity. This, combined with the high turnover under the prior operator and the financial instability of its guarantor, significantly increases your investment risk, as the franchisor lacks a track record of successfully supporting its franchisees.

Potential Mitigations

• A franchise attorney should be consulted to scrutinize the transfer of assets from the predecessors and the obligations of the new entity.
• Careful financial modeling with your accountant is essential to account for the heightened risks of an unproven franchisor entity.
• Engaging a business advisor to perform deep due diligence on the management team's ability to stabilize and support this specific system is critical.

Explanation

The brand has a complex history with multiple predecessors and ownership changes, as detailed in Item 1. The extremely high franchisee turnover rate disclosed in Item 20 and the extensive history of regulatory actions against affiliated companies under the same parent (Item 3) occurred under this previous leadership structure. These historical issues create a significant risk that systemic problems and a problematic compliance culture may persist with the new franchisor entity.

Potential Mitigations

• A thorough review of the predecessor history and the litigation history of all affiliated entities with your franchise attorney is crucial.
• It is important to ask the franchisor what specific changes have been made to address the issues that led to past turnover and regulatory actions.
• Discussing the system's history and challenges with long-term franchisees who operated under the predecessors can provide critical context.

Explanation

Although the new franchisor entity has no litigation history, its affiliated companies and parent organization have a significant pattern of governmental actions. Item 3 details enforcement actions by franchise regulators in California, Illinois, Maryland, Virginia, and Washington against affiliated brands for violations like unregistered sales and failure to disclose required information. This suggests a potential compliance weakness within the overall organization, which is a major risk.

Potential Mitigations

• Your attorney must review the details of every government action disclosed in Item 3 to understand the nature of the violations.
• Treating a pattern of regulatory actions within a franchise organization as a serious red flag is a prudent approach.
• Inquiring with the franchisor about the compliance systems they have implemented to prevent such issues from recurring is an important step.