“Ten Key Points When Investing In A Franchisor Business”		«BACK
	by Dennis L. Monroe
	from October 2005 Franchise Times

This article is a first in a two-part series.  This month’s column will explore the top ten franchisor decision points.  (Please note:  these issues are not an all inclusive due diligence checklist but a key matrix for a potential investor.)

Franchisor Due Diligence Checklist:

1. Unit Economics.  The key to any franchisor’s value is having a concept with solid unit economics.  If the units are developed properly and care is given to planning prior to opening, this will result in solid unit economics, successful franchisees and a viable system.  Solid unit economics are the backbone of a franchise system. 
2. Concept Nitch.  A concept with staying power is key.  A good, viable concept must have legs, not be easily duplicated, and be unique.  These qualities are difficult to evaluate and are tied to consumer and demographic trends.  We have seen many examples of concepts that did not have staying power (such as bagels and meal replacement). 
3. Corporate Store Development.  Franchisors that have strong investment potential have a core of strong corporate stores.  These corporate stores:  (a) help prove out the concept; (b) allow the franchisor to experiment; (c) provide a solid liquidity base for the corporation; and (d) provide good cash flow.
4. Franchise Units That Can Be Duplicated.  Successful franchise are units that can easily be replicated by qualified franchisees.  A franchisee is usually not an innovator but an implementer.  A good franchise program recognizes and provides substantial operational support.
5. Franchisor Balance Sheet.  It is important to understand the franchisor’s balance sheet to make sure the franchisor does not have “a lot of hair” on the balance sheet.  A messy balance sheet makes it very difficult for a franchisor to sell franchises.  Inadequate liquidity, excessive debt and contingent liabilities create problems in attracting franchisees and creating real value for the franchisor.  In many cases an investor may come in to clean up these issues (which is a different story) but the investor should still make sure there are minimal contingencies.  It may not be enough to just review the franchisor’s balance sheet.  An investor must still review related entities (such as the corporate stores to ascertain the whole financial picture).
6. Intellectual Property Rights.  Intellectual property is probably the most important franchisor asset.  It is important these rights (i.e., trade marks, trade dress, trade names) are protected and defended.  It is crucial the franchisor has an active program for continuing to protect and secure its intellectual property rights.
7. Royalty Payments.  One of the true reflections of a problematic system is when franchisees are not current in their royalty payments and other required payments to the franchisor.  This type of problem may indicate:  (a) the franchisees are not performing well; or (b) the franchisor is not selecting appropriate franchisees; or (c) there are disputes between the franchisee and franchisor.  Any of these scenarios are trouble for a potential investor.
8. Development Agreements.  A well-managed franchise system has reasonable development agreements that do not expect the franchisees to develop too quickly or give away substantial territorial rights without adequate performance standards.  A franchisor that has effective development rights and has put together a thoughtful development plan (which is consistent with realistic development), has a significantly greater value than franchisors with hap-hazard development programs that are constantly re-negotiating development agreements. 
9. Reasonable Franchise Documents.  Strong franchise systems have reasonable corporate documents.  Further, they do not over-paper every franchisee transaction, and do not create onerous situations while still protecting their rights.  Over lawyering can be expensive and discourage prospective franchisees.
10. Franchisor/Franchisee Relationships.  A strong system has a partnership approach between the franchisor and its franchisees.  This franchisor refers to their franchisees as franchise partners.  If it is only lip service, it does not mean much.  A true, viable relationship between the franchisor and franchisee is exhibited when the franchisor recognizes its franchisees as their customers.  To discern the franchisor/franchisee relationship, review the UFOC to see if (a) there is significant litigation; or (b) a continuous franchisee advisory council. 

Obviously, there are many other items a potential investor should examine (such as performing a detailed analysis of the financial statements, and noting the volatility of the various unit economics and strength of the individual franchisees), but if the above ten items are taken into consideration, they provide a good start point to finding out if the franchisor is strong and worthy of investment.

Next month’s column will explore the top ten franchisee issues for a potential investor.