10 Questions to Ask Before Buying a Franchise — Reviewed for Reliability

Item 19 of the FDD is the only section where a franchisor can legally share financial data about what franchisees actually earn. It is also the section most commonly used to mislead buyers. Watch for: gross revenue averages (which tell you nothing about profit), top-quartile earnings presented as typical, and figures for company-owned locations that benefit from favorable real estate or lower marketing costs. Ask specifically for median net income — not average, not gross revenue — for franchisees who have been open more than two years. If they can't or won't provide it, that's your answer.

Item 20 of the FDD contains a table of all franchise outlets — how many opened, transferred, and terminated in each of the past three fiscal years. Most buyers skip this entirely. The ratio of terminations to transfers is the signal: a transfer means a franchisee chose to sell (usually a positive sign). A termination means the franchisor ended the relationship — often because the location was underperforming. A high termination rate relative to system size is direct evidence of unit-level economics failure. Count the numbers yourself. The math doesn't lie even when the sales pitch does.

Item 20 lists contact information for all franchisees who left the system in the past year. This list is required by law. These are the people the franchisor most wants you not to call. Call them. Former franchisees have no incentive to protect the franchisor. Their candor is the most valuable signal you'll collect during the entire diligence process. Ask open-ended questions: Why did you leave? What would you tell someone about to sign? What was your actual financial performance in the final year? Budget 30 minutes per call and aim for at least 5 former franchisees.

Most buyers assume they're getting an exclusive geographic area. The reality for many modern franchise systems is considerably more complicated. Standard carve-outs include airports, stadiums, military bases, and hospitals. More significantly, most franchise agreements explicitly carve out digital and online sales — meaning the franchisor or another franchisee can sell products online to customers in your territory with no restriction. Ask for the exact territorial definition in writing and read it with your franchise attorney. Ask specifically: Can the franchisor open company-owned locations in or adjacent to my territory?

Item 7 presents the estimated initial investment. What it shows and what you'll actually spend are often meaningfully different numbers. Construction costs have increased significantly — the mid-point of a 2022 Item 7 range may be the bottom of the 2026 actual range. Working capital is the most prone to understatement. Item 7 typically shows 3 months of working capital. The reality for most new franchise locations is that you need 6–12 months of operating expenses before revenue stabilizes. The gap between those two numbers is where first-year franchise failures happen.

Royalties are calculated as a percentage of gross revenue — not profit. A 7% royalty on $300,000 in annual gross revenue is $21,000 per year regardless of whether your location made $50,000 in net income or broke even. A system with an 8% royalty and a 3% marketing fund contribution is extracting 11% of your gross revenue before you cover a single operating expense. Build the full unit-level P&L with royalties factored in from day one. Model what your net income looks like if you hit 80% of projected revenue in year one — which is not uncommon for a new location.

Every franchise sales presentation includes a list of support offerings. The only way to evaluate support is through your validation calls. Ask existing franchisees: How often does your franchise business consultant actually visit or call? When you had a problem in the first 90 days, how quickly did they respond? A franchisor with 1,200 locations and three regional support staff has fundamentally different support capacity than one with 120 locations and 15 dedicated consultants. Ask about the franchisee-to-support-staff ratio.

Net unit count trend is one of the cleanest leading indicators of franchise system health. Pull the unit count from Item 20 for the past three years and calculate the net change: new openings minus closures. A declining unit count means one of several things: the economics aren't working for franchisees, the brand has a consumer relevance problem, or the support structure is failing. A system with declining unit counts that is still actively selling new franchises deserves extra scrutiny. Also distinguish between organic openings and acquisition-driven unit count growth — the latter can mask organic attrition.

Validation calls are the single most important part of franchise due diligence — and the step most buyers approach passively. Do not call only the franchisees the franchisor recommends. Call franchisees in markets similar to yours, franchisees who have been in the system for different lengths of time, and franchisees in both high-performing and average markets. Aim for 10–15 calls. Structure each call around specific questions: What were your gross sales in years 1, 2, and 3? What is your current net income after all expenses? Would you choose this franchise again? Listen for patterns across calls, not individual anecdotes.

Hiring a franchise attorney is not optional. The provisions that create the most post-close problems — termination triggers, transfer restrictions, encroachment language, personal guarantee scope, post-term non-competes — are provisions that a generalist may miss or underweight. Budget $1,500–$3,500 for a full FDD review. Key items your attorney should specifically address: Item 6 (all recurring fees beyond royalties), Item 8 (required purchases from approved suppliers), Item 12 (territory rights and encroachment), and Item 17 (renewal, transfer, dispute resolution, and termination). You have maximum negotiating leverage before you sign. Once the franchise agreement is executed, the terms are fixed.