20 Tips to Avoid Buying a “Zombie” Franchise

20 Tips to Avoid Buying a “Zombie” Franchise

Opinions expressed by Entrepreneur the contributors are theirs.

The “zombie franchises” are out there. What is a zombie franchise? He’s the one who’s stalled but still markets his franchise opportunity as if nothing had happened. The brand generally declines in terms of relevance and number of open units. Formerly loyal customers are being diverted to more innovative concepts. The underlying demographics may have changed. Market trends may go against the mark, but management hasn’t blazed a new trail. The economy at the unit level is weakening. Management inertia or denial can compound brand issues.

Zombie franchise systems are usually filled with franchisees who would gladly quit if they could! A poor economy at the unit level and an undercurrent of franchisee discontent are scaring off buyers, so resale volumes are low. Expansion-minded franchisees look outside the brand.

Related: 5 Strategies to Avoid the Most Common Franchisee Mistakes

Don’t be tricked

New franchisees who miss the signals eventually realize their mistake. They may feel that the disclosures were inadequate or misleading. They often look back on conversations with franchisees and wonder how they didn’t hear the negative comments. They may recall sunny conversations with consultants/brokers and the corporate team and feel cheated. Or maybe the company is really out of touch and doesn’t even realize there’s a problem! All of this destroys the trust of the franchisees and generally the relationship.

Franchisees in a zombie system are typically chained to the business with personal guarantees, a site lease, equipment or vehicle leases, a loan from the Small Business Administration (SBA), a loan against their home, a loan against their investments or 401(k) or loans to family and friends. The long-suffering franchisee can’t hire enough help because they can’t afford it, can’t sell the business, and can’t shut it down. They are essentially indentured servants.

Often these brands spend a lot of money on branding and advertising to try to convince potential franchisees that they are still worth investing in. They are trying to invigorate franchise unit sales, but not the underlying business.

Related: 5 Things to Consider Before Owning a Franchise

20 signs of a zombie franchise

You’re too smart to get sucked into a weak franchise concept. Here’s a simple checklist to keep your due diligence on track and avoid zombie franchises. If you’re a founder hoping to sell to private equity, PE will weed out brands with these attributes unless they’re dedicated turnaround investors, so solving these issues becomes your to-do list:

  1. Lack of unit growth, especially through existing franchisees. Talk to as many franchisees as possible. If they don’t want to expand even though the territory is available, I advise them to move on.

  2. Low profitability at unit level

  3. Development agreements not respected. Franchisees would rather lose their deposits than follow through and open the promised units. Section 20 of the Franchise Disclosure Statement lists franchisees and development agreement holders. Connect with these franchises.

  4. Parent company too dependent on the sale of franchises. Look at how much revenue is tied to franchise royalties versus recurring royalty revenue.

  5. The parent company pays more attention to the supply chain and rebates to generate revenue, again usually a signal of declining recurring royalties. Obscure disclosures about discounts and supply chain costs for franchisees should also encourage you to move on to other concepts.

  6. Inflated Funnel Sold Unopened (SNO) or SNO numbers that are quietly adjusting year over year due to low unit openings. Google press releases from the previous year and industry articles. Did management boast of “400 units sold” five years ago, but only 50 units are open, and the rest are still on the list of 20 sold unopened? Red flag.

  7. A growing number of underperforming franchises. Again, it’s worth tracking down old disclosures so you can compare multiple years of performance at the unit level. How resilient is the concept? Are the trends positive?

  8. Franchise stops releasing Section 19 tax returns when Section 19s were consistently included in prior disclosures.

  9. Increase in disputes with franchisees

  10. Franchisees who want to sell before their first license agreement expires.

  11. Potential franchisees give up after considering resale options.

  12. Franchisee discontent is spilling over to websites dedicated to publishing stories of disgruntled franchisees.

  13. During validation, you discover that the franchisees are not following the system. They have developed “hacks” to improve profitability.

  14. Poor franchisee validation, poor franchisee surveys, or other signs of a dysfunctional franchisee-franchisor relationship.

  15. Decreasing candidate funnel

  16. Weakening of customer interest; declining market share.

  17. Company team turnover, especially among field support staff (these are the staff members who work most closely with potentially disgruntled franchisees). Do franchisees give positive ratings to the performance of the management team?

  18. Do you see any danger signs but management seems to be in denial? Compliant? Blame the franchisees? Has anyone from the company’s team already left to become a franchisee themselves? Why not?

  19. Is there evidence of continued investment in innovation to maintain brand relevance? Are franchisees saying this is a problem?

  20. Relatively high Small Business Administration (SBA) loan fees. These are time-lagged indicators, but certainly a worrying signal.

Related: What You Really Need to Look For When Considering a Franchise

Does the list above work? You bet! You owe it to yourself to carry out thorough due diligence. The list above will save you time, money and headaches. If you see weak signals, don’t waste your time. Move on. There are many solid, healthy, and proven franchise options out there. Be picky and protect your time and money. Only the most worthy concepts deserve your attention and commitment.

What if you’re a franchisor and you recognize troubling signals from your own brand in this list? Start by improving the economy at the unit level and rebuilding trust and strong communication with your franchisees. These are the two highest impact areas of any franchise.

Are you interested in eventually selling your franchise business to private equity? Preventing problems in the first place is essential. Any issues can have a big impact on the terms of your deal, the valuation of your business, and even which investors will take a serious interest in your brand. Once you’ve stalled, the bar is raised to prove you’re back on track. Remember that most private equity investors in franchising want a growth story, not a turnaround project. Are you building a valuable reputation?

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