I Have Been Told that a Certain Franchise is a "Goldmine." How Can I Verify This?

While the owner of a franchise company may tell you that their franchise has high earning potential, you should always do your own research before investing money into any franchise. There are several ways to research franchise opportunities, but no matter how you do your research, you should always start by reading the Franchise Disclosure Document (FDD).

Understanding Franchise Disclosure Documents

Franchisors are required by the Federal Trade Commission (FTC) to give you a Franchise Disclosure Document before you buy a franchise. The FDD will have important information, which you should read carefully and completely before signing any contract. The FDD will include information about the franchise's competitors, the business experience of the franchise management/owner team, whether or not the franchise has been involved in any lawsuits or bankruptcies, as well as restrictions on the franchise.

The FDD will also list the costs and fees of starting and operating the franchise. These costs and fees may include the initial purchase fee, owner royalties, legal costs, equipment and product costs, licensing fees, and advertising costs. It is a good idea to obtain an estimate of your first year of costs to compare with other potential franchising opportunities. The disclosure document will also list currently operating franchisees. This is important to know because current franchisees in your area will mean more competition for you and potentially less income.

The disclosure document will also give you the franchisor's financial statements. Be sure to look at these statements, as it does not make business sense to invest in any company that is financially unstable. Furthermore, the contact information of current and former franchisees may be included. Contacting these current and former franchisees is a good way to do additional research on the franchise.

FDD Earning Claims Statements

The franchisor may also provide you with something called an "earning claims statement" in the FDD, which is an optional section of the disclosure document. It will detail the earnings of currently running franchises. All earning claims statements must be prepared according to an FTC-prescribed format. While a franchise owner is not required to disclose potential earnings of a particular franchise, if they choose to do so, they must have a reasonable basis for their claims.

Even if the franchisor has a reasonable basis for their claims, the information they give you may be misleading so it is important to look carefully at it. For example, often times the franchisor will only list the gross sales, which do not include any costs of operating. If gross sales are listed, it is important to be able to estimate the cost of operation, start-up fees, and owners’ royalties that will come out of that figure. The franchisor may also only list the franchises with the best revenue, and not the overall average revenue. Furthermore, the geographic location of the sample size may also make a difference.

Just because someone in a town outside of yours made a certain amount of money from the franchise, doesn’t mean that you will make the same. The disclosure document should give you the sample size and the location of the sample size. Be sure to look at how this claim of income was measured.

Franchises and Legal Issues

The franchisor may ask you to sign a statement regarding whether or not they gave you any information about the earnings of the franchise. If they did, even verbally, you should be sure to record this information. Failure to do so will waive your rights to any claims if there is a future lawsuit. If the franchisor does not provide you with an earnings claim statement, it is even more important to contact the other current or former franchisees listed in the disclosure document to ask them questions about the business.

You should always ask the franchisor any other additional questions you may have about the franchise. For example, you may want to know if the franchisor would sell to another franchisee in the regional area or how many franchises fail per year.

Getting Help

For further clarification of the disclosure document and the earnings statement or general information about investing in a franchise, you should contact an attorney that specializes in franchises for help. While investing in a franchise can be a great business venture, you want to be sure of what you are getting into.