Explanation

The regional franchisor's financials show operating losses, and a Maryland regulator has required a financial assurance due to this condition. Additionally, the national franchisor, SBS Franchising, LLC, has a 'going concern' note in its audited financials related to a large tax liability and dependency on shareholder support. This combination suggests potential financial instability, which could impact the support you receive and the overall health of the brand.

Potential Mitigations

• Your accountant must conduct a thorough review of the financial statements for both the regional and national franchisors, including all footnotes.
• It is crucial to have a business advisor help you assess whether the franchisors have the capital and stability to provide long-term support.
• A franchise attorney should explain the implications of the state-mandated financial assurance and the 'going concern' note.

Explanation

Item 20 data reveals consistently high franchisee turnover across the entire Stratus system. In 2022, nearly 15% of the franchise system was terminated, and hundreds of units were terminated in both 2021 and 2023. This level of churn can be a significant indicator of potential issues with the business model, franchisee profitability, or the franchisor-franchisee relationship, representing a substantial risk to your investment.

Potential Mitigations

• Contacting a significant number of former franchisees from the list in Exhibit E is critical to understanding why they left the system.
• An accountant should analyze the turnover data across all tables in Item 20 to assess the stability of the franchisee base.
• Discuss the high turnover rates directly with the franchisor and existing franchisees with guidance from your business advisor.

Explanation

The system is expanding very quickly, adding over 1,000 units nationally in the last three years. This rapid growth, when combined with the financial weaknesses disclosed in Item 21 for both the regional and national franchisor, creates a risk that the franchisor's support infrastructure (training, assistance, quality control) may not be able to keep pace. This could directly affect the quality of support you receive.

Potential Mitigations

• A business advisor can help you question the franchisor about their specific plans to scale support infrastructure to match unit growth.
• Interviewing a broad range of existing franchisees about the current quality and responsiveness of franchisor support is advisable.
• Your accountant should review the franchisor's financials to assess if they have the resources to support this rapid expansion.

Explanation

Your direct franchisor, Turner Growth Holdings, Inc. (Turner Growth), has a limited operating history, having been formed in July 2018. While the Stratus brand is more established, your primary support and contractual relationship are with this newer regional entity. This relative newness, combined with its disclosed financial condition, presents a risk as the franchisor may lack a long-term track record of providing franchisee support and navigating market challenges.

Potential Mitigations

• A business advisor can help you conduct extensive due diligence on the regional franchisor's management and operational track record.
• It is important to speak with the earliest franchisees in this specific region to understand their experience with this entity.
• Your attorney should review the terms of the relationship between the regional and national franchisor.

Explanation

The brand's trademarks are owned by Diversified Royalty Corp., a publicly-traded Canadian company that specializes in acquiring royalty streams. This ownership structure, similar to private equity, may prioritize financial returns for shareholders, which could potentially influence decisions regarding fees, franchisee support levels, and long-term brand investment. You should consider how this financial focus might affect the system's direction.

Potential Mitigations

• Researching the track record of Diversified Royalty Corp. with its other brands could provide insight into their management style; a business advisor can help.
• It is important to discuss with current franchisees if they have noticed any changes in system focus since this ownership structure was established.
• Your attorney can help you understand any terms that give the ultimate owner control over your franchise relationship.

Explanation

Item 3 discloses two significant past regulatory enforcement actions against the national franchisor's predecessor. Authorities in both California and Virginia took action for "making untrue statements of a material fact" in connection with franchise sales. While these actions involved a predecessor entity, this history of regulatory non-compliance related to franchise disclosure and sales practices is a significant risk factor you must consider carefully.

Potential Mitigations

• A franchise attorney must review the litigation and regulatory history in Item 3 to assess for patterns of misrepresentation or non-compliance.
• Discussing this history with current franchisees may provide context on whether these past issues still affect the system's culture.
• A business advisor can help you weigh the risk of a franchisor with a history of regulatory actions.