Buying into a franchise is a significant investment, and there are various ways to finance the purchase. Common methods include bank loans (often guaranteed by the SBA) and ROBS.
For a potential franchisee, it is never too early to start looking into financing. Particularly for SBA loans, the process can take from several weeks to several months. A potential franchisee will need to have financing in place before entering into a franchise agreement.
Due diligence is the process of investigating a franchise that a potential franchisee is considering buying into. It helps the potential franchisee determine whether or not the franchise is a sound investment and if it is a good fit for what they are looking for.
As part of their due diligence, a potential franchisee will typically meet with the franchisor (either virtually or in-person), visit active franchised locations, review the FDD, and talk with current franchisees. They may also attend a Discovery Day put on by the franchisor.
The franchise disclosure document (FDD) is a written overview of the franchise. While the statements made in the FDD must be true, it is not a contract nor binding on the franchisor. The FDD is required by federal law and is organized into 23 sections. Including the documents at the end, most FDDs are several hundred pages long.
Information in the FDD includes the identity of the franchisor and its affiliates, a list of fees, an estimate of a franchisee’s initial investment in the franchise, the obligations of the franchisee and franchisor, a description of the territory assigned to the franchisee, and the recent financial statements of the franchisor. A sample franchise agreement is included at the end of the FDD.
Reviewing the FDD is a necessary part of the due diligence prior to buying into a franchise.
The franchise agreement is the contract that sets out the rights and responsibilities of the franchisor and franchisee. It is always drafted by the franchisor, and therefore is usually heavily weighed in favor of the franchisor, who may or may not be willing to negotiate it. The terms of the franchise agreement should mirror those found in the FDD.
The franchisor must wait at least 14 days from the date the franchisee received a copy of the FDD before the franchisor can give the franchisee the franchise agreement to review and sign. Once the franchise agreement has been signed by both parties and the franchisee pays the initial franchise fee, the franchise purchase is complete.
Every potential franchisee must be vetted and approved by the franchisor. While each franchisor has it own requirements, most require at a minimum an interview, review of the potential franchisee’s financials, and a background check.
The formal approval process usually begins with the submission of an application by the prospective franchisee. The entire process can be quick, or it can last several weeks. Only once the franchisor has approved the potential franchisee will the franchise agreement be drafted by the franchisor.
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