Franchise Red Flag: Top 10 Red Flags You Should Notice When Evaluating a Franchise Opportunity

Investing in a franchise can be a great way to start a business, and for foreign entrepreneurs looking to enter the U.S. market, the E-2 visa can be a useful tool. This visa allows investors to enter and work in the U.S. based on their investment in a U.S. business, making it an attractive option for those looking to start or expand their entrepreneurial ventures. However, not all franchise opportunities are suitable for E-2 visa investors, and it’s crucial to thoroughly evaluate potential franchisors to ensure that they meet the necessary criteria.

Remember that this article does not provide an exhaustive list of franchise red flag that E-2 visa investors should look out for when evaluating franchise opportunities. Rather, it highlights some of the most common warning signs that may indicate a potential problem with the franchisor or the franchise system. It should also be noted that legitimate and trustworthy franchisors may have systems that meet one or more of the criteria listed below. But, if a franchisor meets several of these criteria, it may suggest deeper issues with the franchise system that could impact your investment.

As a potential E-2 visa investor, it’s critical to carefully assess each franchise opportunity and conduct thorough due diligence before making investment decisions. Find the right franchise consultant to help you assess and analyze the franchises options. Considering that, look at the top seven franchise red flag to watch out for when evaluating franchise opportunities:

An incomplete or poorly written Franchise Disclosure Document (FDD)

When considering a franchise opportunity, one of the first things to review is the Franchise Disclosure Document (FDD). A poorly constructed or incomplete FDD can be a significant franchise red flag for potential franchisees. It can indicate that the franchisor needs legal counsel or needs to take the time to review and edit the document carefully. This lack of investment in the FDD may suggest a broader lack of investment in the franchise system as a whole, which could negatively impact the success of your investment. Click here to learn more about the FDD and how to buy a franchise.

Limited franchisee network despite several years of operation

For a mature franchise concept, a low number of franchisees after several years in operation can be a concerning red flag for potential franchisees. It could indicate a lack of commitment to the franchise system or fundamental issues that hinder potential franchisees from pursuing the opportunity. While this may not apply to new franchisors, evaluating the reasons behind the low number of franchisees before investing in a particular franchise system is important. A franchisor dedicated to its system’s success should have a solid track record of successfully recruiting and supporting franchisees.

High franchisee turnover

The FDD should list all franchises that have closed or transferred ownership in the last three years. While a few closures or transfers are normal, a long list may indicate trouble. It could indicate that the franchisor needs to expand more quickly, provide sufficient support to franchisees, or may have a flawed business system. Further, if many existing franchises are up for sale, reach out to understand why they’re leaving. A poor economy may cause franchise sales to decline, but numerous franchise locations for sale suggest underlying problems with the franchise system.

Too many franchisee-related lawsuits

Before signing a long-term franchise agreement, consider Item 3 of the FDD, which lists franchisee-related lawsuits. If the FDD discloses a significant number of lawsuits, whether initiated by franchisees against the franchisor or vice versa, it may indicate potential issues. It’s best to avoid investing in a franchise with a history of numerous lawsuits against it. However, this may not necessarily be a franchise red flag if the franchise has initiated lawsuits to defend it’s brand and reputation. Ultimately, it’s highly recommended to consider the legal history of a franchise before making any investment decisions.

Poor brand equity

Consider a franchise’s brand equity before investing, as poor brand reputation can lead to declining sales and profitability, requiring significant time and resources to regain customer trust and loyalty. Investigate public complaints and negative reviews from current franchise owners before committing to the franchise system. While a low-reputation brand may offer improvement opportunities, be prepared for the added risk and longer-term investment needed to enhance its brand equity.

Inexperienced management team

While it may be tempting to join a new franchisor with a unique concept, the franchise’s success would ultimately depend on the competence and expertise of its leadership team. With the right expertise, leadership, and guidance, a franchisor can effectively support its franchisees, develop and refine its business system, and respond to changing market conditions. On the other hand, an experienced management team can provide valuable guidance and support to franchisees, helping them navigate challenges and optimize their operations. Thus, look for evidence of the management team’s success as entrepreneurs or executives in other industries.

High franchise fees

High fees can be a major franchise red flag, but determining what constitutes “high” can be challenging, as most costs are for intangible assets. For instance, royalties are typically calculated as a percentage of sales, ranging from 5-6% but can be as high as 15%. In other cases, franchisors charge a fixed fee regardless of sales levels. Regardless of your pay, you should feel comfortable with the justification behind the numbers. Therefore, research the franchise thoroughly and seek advice from legal professionals before purchasing.

No geographical limitations

In some cases, the lack of geographic restrictions may indicate a franchisor’s eagerness to expand quickly, but it could also mean a lack of consideration for their franchisees’ success. The absence of clear boundaries can result in a saturated market, making it harder for franchisees to establish a customer base and generate revenue. Additionally, the franchisor’s lack of concern for the franchisee’s territory can lead to a loss of trust and even legal disputes. Review the FDD carefully and ensure it includes clear and enforceable geographic limitations.

Downward sales trend

A significant drop in revenue or a consistent downward trend in sales can signal underlying problems within a business. These issues may stem from the quality of the product or service, increased competition in the market, or ineffective management. Although a temporary decrease in sales is typical, it’s essential to pinpoint the cause of the decline and determine if it can be remedied. On the other hand, a downward sales trend can also present an opportunity to acquire the franchise at a discounted price and implement strategies to improve sales. Analyzing financial statements and market trends can aid in detecting potential warning signs and opportunities for expansion.

A poorly organized or rushed discovery day

A discovery day is a perfect chance for the franchisor to showcase its brand, values, and support systems to potential franchisees. A disorganized presentation that needs more details or appears unprofessional may suggest a lack of focus on details or interest in building a positive relationship with franchisees. As a potential franchisee, take note of the level of professionalism and dedication demonstrated by the franchisor during the discovery day, as it can indicate the level of support and care you can expect throughout your franchise journey.