In its January issue, Entrepreneur Magazine published its Annual Franchise 500 for 2007.  One of the more interesting articles in the issue had to do with conducting due diligence.  As I recommended in a previous post the article discussed the importance of interviewing as many franchisees as possible in order to gain information about the franchisor.  Unfortunately most prospective franchisees do not conduct even basic due diligence, the article says.  Here are highlights of the article:

If you want to know more than the splashy brochures and franchise salespeople will tell you, then roll up your sleeves.  You can use a variety of methods to dig deeper and get the real lowdown on a franchisor.  The good news:  Most of these techniques are cheap or free.

1.  Mine Franchisees:  Be sure to ask tough questions.  Don’t just shoot the breeze.  Also visit franchisees at their stores.  You get more information and it is an opportunity to see the franchise in operation.

2.  Dig in the UFOC:  The UFOC lists a great deal of information but many franchisees do not even give it a glance.  The UFOC will contain information about lawsuits, revenues and management.

3.  Ramp Up Research:  Search the Internet.  Are there any gripe sites?  See UPS Store www.thebrownboard.com and Quiznos www.toastedsubs.info as examples of gripe sites.  Be sure to take what you read on the Internet with a grain of salt and verify what you learn.

4.  Meet the Management.  Ask the tough questions of management as well.  One expert recommended that you ask the franchisor whether they will let you out of their franchise agreement if you are unhappy?  If they respond "Yes", they are lying and will say anthing to get you to sign.  (Franchise agreements are enforceable contracts and I have yet to deal with a franchisor that will let you out of an agreement voluntarily).

5.  Know the Market.  Do the market research and understand how the franchise fits into the competitive picture.  Also, think about how the market is going to change. 

6.  Get Advice.  The article advises to go to SCORE, have an accountant review the franchisor’s financials and have an attorney review the franchise UFOC and franchise agreement.

Update:  I received an email today from a franchisee regarding this post.  He pointed out that the most difficult  information to obtain and verify is franchisee profitability.  He pointed out that the profitability of the franchisor and the franchisees is not always related.  He correctly stated that sometimes those selling franchises make money while the franchisees do not.  And it is not always due to lack of due diligence on the part of the franchisee.  It may be because of inaccurate information supplied by the seller or franchise support that was promised but never delivered.

Forbes Magazine had an interesting article that provides Ten Good Reasons Not to Buy a Franchise.  Number 1 on the list is Questionable Profitability.  That makes extensive due diligence all the more important if you are considering a franchise purchase.