Everything You Need to Know Before You Sign — The Complete Guide to Buying Your First Franchise
Know what you're signing before you sign it.
"Before we talk about FDDs and SBA loans, let's talk about the thing no franchise broker will ever tell you: franchising is not a passive investment."
It's a business. It's a job. And if you go in expecting the system to do the work while you collect checks, you're going to have a very expensive education.
That said — franchising is one of the most validated paths to business ownership available. You're buying a proven system, an established brand, and a playbook refined by hundreds (sometimes thousands) of operators before you. The failure rate for franchises is substantially lower than for independent businesses. That's the deal.
They follow systems. The fastest way to fail is thinking you know better than the franchisor. The brand's consistency depends on system compliance.
They're good with people. Even "passive" franchises require managing vendors and landlords. Customer-facing concepts are intensely people-oriented.
They have enough capital — and then some. Real-world costs run 10-20% above published estimates. Have 20-30% more than the top end of Item 7.
They're ready to be operators. The "semi-absentee" model takes years to build. Plan for active involvement in years 1-2.
The pure investor. Franchising requires active involvement. It's not a place to park capital and collect passive returns.
The brand-chaser. Recognizing the name doesn't make it a good investment. Some of the best opportunities are brands you've never heard of.
Those who can't afford to fail. Never invest money you'll need for living expenses within 2-3 years.
Write down what you want out of a franchise before talking to a single development representative. Income replacement? Equity building? Multi-unit empire? Your answer determines which opportunities are actually right for you.
A franchise is a license. You're paying for the right to operate under a brand's system, within a defined territory, for a defined period of time — in exchange for an upfront fee and ongoing royalties.
| Fee Type | Typical Range | What It Is |
|---|---|---|
| Franchise Fee | $20,000 – $100,000+ | One-time upfront license fee |
| Royalty | 4% – 8% of gross sales | Ongoing brand/system usage fee |
| Ad Fund | 1% – 4% of gross sales | Cooperative marketing pool |
| Tech Fee | $200 – $2,000/month | POS/management systems |
| Renewal Fee | $5,000 – $25,000 | Paid at each term renewal |
| Transfer Fee | $5,000 – $25,000+ | Paid when selling your franchise |
Most franchise agreements run 10 years, with renewal options. Renewal is not automatic — the franchisor can decline to renew, and renewal typically requires signing the "then-current" agreement (which may have different, higher fees). Some renewals require you to remodel or re-equip at your expense — a potential six-figure surprise.
Your territory defines where you can operate and (sometimes) where the franchisor cannot open competing units. "Protected territory" only means what the franchise agreement says it means — many agreements have carve-outs for alternative channels even within protected areas.
You can sell your franchise to a qualified buyer, subject to franchisor approval and a transfer fee. The franchisor often has a right of first refusal. Understanding the resale market before you buy is important — it's part of your exit strategy from day one.
Franchise brokers are paid by franchisors ($10,000–$30,000+ per signed deal). They're incentivized to match you with brands that pay high commissions and are actively recruiting — not necessarily the best fit. Use them as a starting point, not your sole advisor.
Start with 20-30 concepts. Apply these filters to get to 5-8 serious candidates:
Request FDDs from all serious candidates. Your real evaluation begins when you have the documents in hand.
The Franchise Disclosure Document is a legally required document governed by the FTC's Franchise Rule (16 CFR Part 436). Every franchisor must provide it at least 14 calendar days before signing any agreement or exchanging money. Most FDDs run 200-500 pages. Here's what's in them.
What it is: Corporate background — structure, how long in business, how long franchising (often different), and related entities.
What to look for: Stability of ownership and structure. Is this a young franchisor despite being an old company? Is private equity involved?
🚩 Red flag: Frequent changes in corporate structure, ownership, or brand name over recent years.
What it is: 5-year bios for every officer, director, and manager who will have significant dealings with franchisees.
What to look for: Franchise operations experience in the team. Stability of leadership.
🚩 Red flag: Completely different leadership team vs. 2-3 years ago.
What it is: All pending and past franchise-related litigation, government actions, and injunctions involving the franchisor and its principals.
What to look for: Patterns — multiple franchisees suing over the same issue is a system problem, not a coincidence.
🚩 Red flag: Government actions alleging fraud or deception. Franchisee class actions. Multiple suits about the same specific problem.
What it is: Any bankruptcy history for the franchisor, its predecessors, parents, affiliates, and principals within the past 10 years.
🚩 Red flag: Any bankruptcy within the last 5 years with unclear resolution.
What it is: All upfront fees — franchise fee, training fees, and other initial payments.
What to look for: Is any portion refundable? Under what conditions?
What it is: A comprehensive table of all ongoing fees — royalties, advertising, tech fees, renewal, transfer, training, audit fees.
What to look for: Total fee load. Add royalties + ad fund + tech fee. 10-12% of gross sales is manageable. 15%+ is very difficult to absorb.
🚩 Red flag: Fees with no cap. Technology fees that are significant and growing.
What it is: A detailed table of all costs to open — franchise fee, real estate/build-out, equipment, inventory, insurance, working capital, training, and professional fees.
Critical rule: Take the high-end estimate and add 20%. That's your real budget.
🚩 Red flag: Understated working capital (verify with franchisees). Missing major cost categories.
What it is: Requirements to buy goods, services, or equipment from approved suppliers — including from the franchisor itself.
🚩 Red flag: Significant required purchases from franchisor-affiliated suppliers at above-market prices. This is hidden margin extraction.
What it is: A cross-reference table linking your obligations to the relevant sections of the franchise agreement. Read this alongside the full agreement.
What it is: Any financing offered directly by the franchisor — terms, interest rates, conditions, and default consequences.
What to look for: Compare to market rates. Franchisor financing is sometimes at above-market rates.
What it is: Everything the franchisor commits to providing — training, site selection, grand opening, ongoing support, advertising materials, technology systems.
What to look for: Specific commitments with hours and timelines. "We provide training" means nothing. "5 days at HQ + 2 weeks on-site" is a commitment.
Ask franchisees: Was what was promised actually delivered?
🚩 Red flag: Vague commitments. No dedicated franchisee support team. No field visits.
What it is: Your territory boundaries and any protection — plus conditions under which the franchisor can operate or sell in or near your area.
What to look for: Is the protection real? Watch for carve-outs for alternative channels (delivery apps, kiosks, airports). Does protection cover all distribution, or just brick-and-mortar?
🚩 Red flag: Vague territory definitions. Broad alternative channel carve-outs.
What it is: Trademarks, service marks, and trade names you'll use — and their registration status.
What to look for: Federal registration on the USPTO Principal Register. State registrations provide weaker protection.
🚩 Red flag: Unregistered marks, contested registrations, or pending oppositions. You could spend years building a brand you're then legally required to change.
What it is: Patents, copyrights, and trade secrets (recipes, software) that are part of the franchise system.
What to look for: Does the franchisor have real proprietary IP? Or is the "system" something replicable without the license?
What it is: Whether you're required to personally manage day-to-day operations, or whether absentee/semi-absentee ownership is permitted.
🚩 Red flag: Mandatory owner-operator requirement when you planned to hire a GM.
What it is: Restrictions on your product and service mix — what you must carry and what you're prohibited from selling.
What to look for: Any restrictions that would limit your revenue opportunities.
What it is: The most legally important item. A summary of your rights and obligations for renewals, terminations, transfers, and disputes.
Key provisions:
🚩 Red flag: Short/no cure periods. No-fault termination clauses. Arbitration mandated far from your location. Overly broad non-competes.
What it is: Celebrities or public figures who promote the franchise and their compensation.
What to look for: Would the brand suffer if the celebrity walked away?
What it is: The ONLY place in the FDD where a franchisor can legally make claims about how much money you might make. Optional — only about 50% of franchisors include it. See Chapter 5 for the complete deep dive.
🚩 If there is no Item 19: The franchisor either has no data worth sharing, or the data isn't good. Neither is comforting.
What it is: Three-year data on units opened, closed, transferred, and terminated — plus contact information for ALL current and former franchisees (past year).
What to look for: Unit count trend. Closure/termination rates. Ratio of transfers to terminations (transfers = healthy exit market; terminations = distress).
The franchisee list is gold: Call all of them — especially former franchisees. This is required to be complete by law.
🚩 Red flag: High termination rate. Rapid recent decline in unit count.
What it is: The franchisor's audited financial statements for the past 3 fiscal years.
What to look for: Revenue trends. Profitability. Cash reserves. Revenue sources — is the franchisor dependent on new franchise fees or building sustainable royalty income?
🚩 Red flag: Declining revenue. Negative equity. Heavy reliance on initial franchise fees. Going-concern audit language.
What it is: List of all agreements you'll sign — franchise agreement, lease addenda, personal guarantee, and other contracts.
What to look for: Are there agreements in the list that weren't in the FDD exhibits?
What it is: Two copies of a receipt confirming you received the FDD — legally starting your 14-day review period.
Important: Signing Item 23 only acknowledges receipt. It commits you to nothing. Sign it and start your clock.
Item 19 is where the rubber meets the road. It's the only legal avenue for financial performance claims in an FDD — and it's the single most important item you'll read.
Only about 50% of franchisors include an Item 19. If a franchisor chooses not to disclose financial performance data, ask yourself why. The answer matters.
Is Item 19 showing ALL locations, or just company-owned, just franchisee-owned, or just "mature" units? The more it excludes, the more skeptical you should be.
How many units does Item 19 cover vs. total units? If there are 200 locations and Item 19 covers 127, find out why 73 are excluded.
Averages get pulled up by star performers. A system with 10 units doing $2M and 90 units doing $400K has an "average" of $560K but a median of $400K.
Take the revenue number and model costs: royalties + ad fund + rent + labor + COGS + insurance + utilities. What's left is your pre-tax income. If it's negative at median unit volume, the economics don't work.
Ask franchisees: "What does your Item 19 say, and what are you actually doing?" The gap between these two numbers is extremely telling.
Item 19 shows revenue, not profit. A franchise doing $1.2M in sales sounds impressive — until you model the full P&L and net $45K after expenses. Always build a complete P&L before evaluating any Item 19 number.
These questions go beyond the pitch deck. How they answer tells you as much as the answers themselves.
Growth is good. Contraction demands explanation. Steady growth with low turnover is ideal.
High renewal rates = franchisees making money. Low renewal rates = warning sign.
Understand your cash burn runway before revenue starts.
A system with 500 franchisees and 3 field reps will not support you effectively.
Do they work with you, or push to terminate? What's their track record?
You're paying into this fund. You deserve transparency on where it goes.
Ask them to explain open cases. Listen for defensiveness or deflection.
A trick question — but illuminating. Honest franchisors sometimes volunteer their problem franchisees upfront.
Any hesitation is a red flag. You're about to invest hundreds of thousands of dollars.
Rebranding, technology mandates, menu changes — all can significantly impact unit economics.
Every system has a failure profile. Honest franchisors know it and will tell you.
Private equity acquisitions are common. Understand what changes under new ownership.
Ask for Franchise Business Review or independent survey data.
Available territory today can be surrounded by competitors in 5 years.
The hardest question to ask. The most valuable answer to hear.
More deals are saved — and more disasters averted — by franchisee validation calls than by any other part of due diligence.
The franchisor's referral list skews toward happy, successful operators. Here's how to reach the rest:
Reluctance to discuss specifics. Overly scripted positive answers (coaching happens). The same complaint surfacing across multiple franchisees (system problem, not an outlier). "I'm fine but others aren't" without explanation.
| Financing Type | Best For | Key Facts |
|---|---|---|
| SBA 7(a) | Most franchise types | Up to $5M. 10-25 yr terms. 10-30% down. 45-90 day process. |
| SBA 504 | Real estate & equipment heavy concepts | 50% bank + 40% CDC + 10% down. Fixed rates. |
| ROBS | Those with $100K+ in retirement accounts | No loan, no penalty, no tax. High personal risk. Needs specialist. |
| Seller Financing | Resale purchases | 10-20% of purchase price. Ask — it's rarely offered proactively. |
| Franchisor Programs | Franchise fee / equipment | Compare rates to market carefully. May carry hidden conditions. |
The SBA 7(a) loan is the most common franchise financing option. Key facts:
ROBS (Rollover for Business Startups) lets you use retirement funds without penalty by creating a C-corp that your retirement plan invests in. No loan, no interest — but your retirement is now your business. If the business fails, so does the retirement account. Use only with a qualified ROBS specialist and if you have other retirement security.
For seller financing on resale deals: it's rarely offered proactively. Ask the seller directly. A motivated seller may take 10-20% as a seller note — which reduces your bank borrowing and aligns their incentive with your success.
A "protected territory" only means what the franchise agreement says it means. Read the exact language. Watch for carve-outs: delivery apps, airport locations, military bases, grocery channels, and kiosk formats are commonly excluded from territory protection.
| Negotiable | Rarely Negotiable |
|---|---|
| Territory size and definition | Royalty rates |
| Transfer fees (sometimes) | Advertising fund % |
| Right of first refusal language | Required suppliers/vendors |
| Initial training timing/location | Core brand standards |
| Development schedule (multi-unit) | IP protections |
| Cure periods for default | Termination rights for major violations |
| Dispute resolution venue | Advertising fund management |
Hire a franchise-specialized attorney. Not a general business attorney. Not your cousin who passed the bar. A lawyer who reads franchise agreements for a living. Cost: $2,000–$5,000. This is the best $5,000 you'll spend. It could save you multiples of your entire investment.
| Single Unit | Area Development (Multi-Unit) | |
|---|---|---|
| Capital required upfront | 1 unit investment | Development fee + capital plan for all units |
| Risk | Lower — one location | Higher — obligated to open on schedule regardless of unit 1 performance |
| Territory protection | Single location protection | Exclusive development territory for the whole area |
| Negotiating leverage | Less | More — franchisors prefer multi-unit commitments |
| Long-term upside | Single location value | Portfolio value — often 2-5x single unit multiples |
Area development agreements commit you to a performance schedule. If unit #1 underperforms, you're still obligated to open #2 and #3 on schedule. Have your full capital plan modeled before signing a multi-unit agreement.
One lawsuit in a large system is noise. Ten lawsuits about the same issue is a signal. Look for patterns — multiple franchisees suing over the same specific problem indicates a systemic issue, not outlier behavior. Any government action alleging fraud or deception is an immediate deal-breaker.
Calculate the annual departure rate: (units closed + terminated + non-renewed) ÷ average system size
If a recruiter claims "most franchisees make $150K" but your Item 19 P&L shows $45K at median revenue — the verbal claim is either wrong or illegal. Under FTC rules, any earnings representation must be backed by Item 19 data. Document every verbal claim. Verify each one against the FDD.
Urgency pressure ("this territory won't last"), franchise fee recently reduced (trouble recruiting), large open areas in dense markets (why hasn't it been claimed?). Good opportunities have natural urgency. They don't look like a used-car sale.
Define criteria. Research 20-30 concepts. Request info from 8-10. Narrow to 5-6 serious candidates.
Calls with development reps. Confirm territory availability. Request FDDs (starts 14-day clock). Organize your financial picture.
Read each FDD systematically. Build your P&L model from Item 19. Engage franchise attorney now. Get SBA pre-qualification call.
10-15 franchisee calls. Discovery day visits. Ask all 15 hard questions. Begin site selection.
Attorney review complete. Financing arranged. Negotiate any modifiable terms. Sign or move on.
The first year is hard. Not impossible — but harder than the presentations suggest.
| Period | Reality |
|---|---|
| Months 1–3 (pre-opening) | All cost, no revenue. Lease, build-out, hiring, training. This is normal. |
| Opening month | Grand opening momentum is real but temporary. Don't model around it. |
| Months 2–6 post-open | Revenue normalizes. You're learning what your actual unit looks like. Often the most disorienting period. |
| Months 6–18 | Operational competence building. Clear picture of whether you'll hit projected economics. |
If you're significantly underperforming system averages by month 9-12, request a field support visit immediately. Get help early — not after the working capital is gone.
| Item | Topic | Key Question |
|---|---|---|
| 1 | The Franchisor | How old is the system? Who are the parents? |
| 2 | Management Team | How long has leadership been in place? |
| 3 | Litigation | Any patterns? Government actions? |
| 4 | Bankruptcy | Any recent filings? |
| 5 | Initial Fees | Refundable under any circumstances? |
| 6 | Ongoing Fees | Total fee load as % of sales? |
| 7 | Initial Investment | High-end estimate plus 20% = your real budget |
| 8 | Supplier Restrictions | Franchisor margin on required purchases? |
| 9 | Your Obligations | Read alongside the franchise agreement |
| 10 | Financing | Terms vs. market rate? |
| 11 | Support & Training | Specific hours and commitments? |
| 12 | Territory | Protected? What channels are excluded? |
| 13 | Trademarks | Federally registered on Principal Register? |
| 14 | IP/Patents | Real proprietary IP or generic system? |
| 15 | Owner Involvement | Owner-operator required? |
| 16 | Product Restrictions | Revenue opportunity limitations? |
| 17 | Renewal/Termination | Cure periods? Transfer rights? Dispute venue? |
| 18 | Public Figures | Brand dependency on celebrity endorser? |
| 19 | Financial Performance | All units included? Median vs. average? |
| 20 | Outlet Data | Turnover rate? Full franchisee list obtained? |
| 21 | Financials | Revenue sources? Equity trends? Audit notes? |
| 22 | Contracts | Any contracts not in the exhibits? |
| 23 | Receipt | Sign to start your 14-day clock |
Full 25-question version available in the FDD Analyzer Toolkit.
Opening: "I'm doing due diligence on [Brand]. I appreciate your time — all responses are off the record."