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TheStreet Open House

3 Companies Franchisees Should Be Cautious Of

NEW YORK ( MainStreet) -- Choosing to invest in a franchise means figuring out which systems hit on several key areas, including strong management, good unit economics and brand awareness. Of course, not every franchise rates the same. While some franchises are worth two thumbs up, others should indicate a note of caution when investing in them.

The Great Recession has definitely put its mark on more than one franchise chain, leaving many current franchisees to deal with the problems of their parent company. With credit access open prior to the recession, franchisors pushed rapid expansions, but some did less than their share of due diligence on who was investing -- and running -- stores.

There are plenty of warning signs that a parent company may not be ready to take on more franchise stores, such as fewer new stores opened (including ones indefinitely "under construction"), slower supply deliveries and a pullback on national advertising.

A potential franchisee might not notice some of the warning signs. So to start, a Google (GOOG) search should set you on your way to find out information about the franchise. If a franchise has legal problems, for instance, which should be a major deterrent, you can probably find that out simply by checking the Web.

More formally, companies are also required to give potential franchisees a Franchise Disclosure Document, or FDD. Not only does the federally-required prospectus hold information on the actual terms of your franchise agreement, but the FDD will give you a reasonable look-through into the company in typical areas such as company history, financials, ongoing litigation as well as background information about existing franchisees, including numbers on whether the system is growing or contracting.

Steve Olson, president of Franchise Media Update Group, says if franchisors put any information under Item 19 of the FDD, that's a good sign, since they aren't required to fill out that section. This is the area where franchisors can disclose earnings details, expenses and factors that might affect future financial performance.

Experts agree that it is imperative for potential franchisees to talk to and visit with multiple current franchisees.

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