It is one thing to tell business owners to invest a significant amount of time to determine whether a franchise is a good fit, but what about risk? Not all franchise opportunities are created equal, and some are bound to be safer investments than others. By using five simple tests, potential franchisees can decide whether a franchise is a good investment or a poor one.

According to Entrepreneur magazine, most of the information needed to satisfy the following tests can be found in a company's Franchise Disclosure Document or in conversations with franchisors and unit owners.

The simplest test that potential franchisees can do is look at a franchise company's rate of growth. Are the number of operating units increasing, staying constant or declining? This information is published in item 20 of the FDD, the magazine writes, and can also be obtained from annual studies and reports such as Entrepreneur's Franchise 500. While franchisor's may have a variety of plausible and reasonable explanations if their number of units are declining, it is still a "huge red flag" that a company may not be as solid an investment as they appear.

Statistics can even help interested individuals get a grasp on a franchise's management style. Litigation history can be a good indicator of what the franchisor/franchisee relationship within the company is like. Item 3 of the FDD contains information on litigation during the last few years. An increase in litigation generally means that more franchisees are struggling or failing - if it is a rather high number, potential franchisees will need to ask themselves, how much help a company seems to be wiling to offer.

Franchises are required to provide interested parties with their last three years of audited financial statements. When evaluating these documents, investors should look to see if the franchisor if financially stable - they should check for a positive cash flow and strong capital reserves, Entrepreneur advises.

Not all necessary information is disclosed in the FDD, however. Same-store sales trends allow franchisees to find out if sales figures for a system have increased, gone down or remained level over the past few years. Clearly, a potential franchisee should look for businesses where sales are continuing to increase - sales that are flat or decreasing indicate that a business may be susceptible to economic downturns.

And of course, speaking with existing franchisees is always a good tactic. They can give a quick and clear impression of not only how business within the operation has been, but also how they feel in general about the franchisor. A quick read can be obtained regarding the system by asking basic questions, including: How do you feel about the business? Would you do it again?




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