By Alicia Miller
Managing Director, Catalyst Insight Group
Franchisors are required to include a significant amount of information in their Franchise Disclosure Document (FDD,) which is then shared with prospective franchisees, regulators, and lenders. Start-up costs, royalties, ongoing fees, the number of units that opened / closed / transferred, ongoing obligations by both parties, trademarks, legal activity, management backgrounds, ownership information and history, financial performance representations, territory definitions, franchisor support provided, and many other important pieces of information are typically included.
What’s NOT included? Overt reporting on the health of the franchisor-franchisee relationship and franchisee satisfaction.
This is an interesting gap in the current FDD structure, which is mandated by regulators. A strong franchisor-franchisee relationship and franchisee satisfaction are arguably two of the most important indicators of brand trajectory. And yet, these are not openly documented or mentioned anywhere in the FDD.
Of course, if there are large number of exits, or numerous disclosed litigation issues, or heavy management turn-over from year to year, then a brand’s problems are quite visible in the FDD. But in many cases, brewing trouble is NOT visible within the context of the FDD. In fact, the FDD might convey quite the opposite impression to outsiders. For example, insiders know that in a strong franchise, most franchisees want to expand. Prospective owners without franchise experience might instead see many new territory sales as a signal of strength, and never pause to wonder why existing owners aren’t expanding instead. Lack of litigation isn’t automatically a positive signal. Low management turnover doesn’t mean strong value creation for franchisees. Lack of closures doesn’t equal franchisee profitability. The existence of a Franchise Advisory Council (FAC) shouldn’t imply a functional franchisor-franchisee relationship. And so on.
Out of more than 4,000 active franchise brands, it would not be an exaggeration to say that there are perhaps hundreds of franchise brands (of all sizes) that are basically stalled out or headed for trouble, right in plain sight. They may have reasonably healthy balance sheets, low corporate turnover, and little or no disclosed litigation. But that surface calm can belie significant underlying structural, unit-level profitability, brand, or franchisor-franchisee relationship problems. That’s why it is critically important for prospective franchisees to speak to as many current and past franchisees as possible. Franchisees are the best possible source of information about a brand and what it’s really like to be a franchisee of that brand. Would they do it again? Is the brand likely to grow and thrive long term? Do they like working with the corporate team?
Since it can be a challenge to speak to every franchisee, any sensible franchise purchase process should also include reviewing franchisee surveys – ideally conducted by an outside third party such as Franchise Business Review. Surveys document the health of the franchisee-franchisor relationship across many touchpoints. Good surveys poll about brand strength, marketing execution, technology infrastructure and direction, trust in the corporate team, fees, value delivered, and other key topics. This franchisee scorecard is the critical missing element that you will not find in the FDD.
Dig into the report and really try to understand what’s captured. Use the information to ask pointed questions when you speak to the franchisor team and to franchisees. Look for trends. Find out how the management team uses the survey to improve. Do they really hear the feedback? What tough feedback did they receive in the past, and what changed as a result? Are franchisee survey results baked into corporate compensation or performance evaluation? How do results compare to same sector competitors? To franchisees across all brands?
One of my favorite features of the FBR survey is the comparison of scores from that one franchise to all other franchise brands. Since the scores are aggregated across many different franchise sectors and brands of all sizes, it’s easy to see where one brand might be lagging industry averages. It’s also harder for a franchisor to dismiss poor feedback as an outlier or sector-specific for the same reason.
Before investing in any franchise, take the time to interview franchisees and review franchisee survey results for that brand. You will get a wealth of information that isn’t captured anywhere in the required disclosure documents, and may actually shed new light on the FDD itself. Start your research here.
Alicia Miller is the Managing Director of Catalyst Insight Group, a management-consulting firm and trusted advisor specializing in providing strategic, tactical, and operational guidance to franchise leadership teams and private equity investors. They help brands create sustainable growth and drive maximum value for both brand stakeholders and franchisees. Contact: [email protected]