Franchise Red Flags: What to Avoid

Be vigilant and listen to your gut. Certain signs can indicate instability, poor management, or a flawed business model.

Franchisor and System Red Flags

• Excessive Litigation (Item 3): A high volume of lawsuits, especially where franchisees are suing the franchisor for breach of contract or non-performance.

• High Turnover (Item 20): A pattern of many terminations, non-renewals, or transfers over a three-year period. This suggests franchisees are either failing or are deeply unhappy.

• Revenue from Fees, Not Royalties (Item 21): If the franchisor generates the majority of its revenue from selling new franchises (Initial Fees, Item 5) rather than the ongoing royalties (Item 6) of existing units, their focus may be on sales, not support.

• Constant Tinkering: If the franchisor is constantly changing the core business model, it may indicate a concept that hasn't been truly proven.

• Evasive or Aggressive Sales Tactics: A franchisor who pressures you to sign quickly, offers unexpected steep discounts, or seems unwilling to let you talk to franchisees is a major concern.

Financial and Contractual Red Flags

• Unrealistic Financial Projections: If a franchisor makes sweeping, verbal earnings claims that are not supported by the written FPRs in Item 19, walk away. Unauthorized earnings claims are a violation of FTC rules.

• Vague or Unprotected Territory (Item 12): A territory that is not clearly defined or, worse, is explicitly unprotected, leaving you open to immediate competition from another unit.

• Hidden Fees (Item 6): Ongoing required payments (like technology or marketing fees) that seem disproportionately high for the services you receive, or where the franchisor profits from being a mandatory supplier.

Hire Your Professionals

You are not expected to be a lawyer and an accountant simultaneously. Before you sign anything, you should hire specialized professionals.

1. Franchise Attorney: To review the FDD and the Franchise Agreement. They can explain your contractual obligations, termination clauses, non-compete rules, and territory rights.

   *Broken Ladder Advisors offers a free consultation with our preferred franchise attorney.

2. Franchise Accountant (CPA): To analyze the franchisor’s financial statements (Item 21), help you project your startup costs (Item 7), and create realistic profit and loss projections using the data from franchisee validation calls.

The due diligence process is your insurance policy. It requires time and money, but it dramatically increases your odds of selecting a solid, reputable system that aligns with your financial and personal goals.