Why Due Diligence Is So Important

Author: jeff.lefler@franchisegrade.com

Date: SEP 19th, 2014

Topic: Industry Experts

Investing into a franchise is a rewarding business opportunity for a lot of people.

Unfortunately though, some franchised businesses do fail. In reality, franchising is risky. There is an inherent competition for profit within the franchised business between franchisees and the franchisor. Our research shows that approximately 15,000 franchised outlets have ceased operations each year within the U.S between 2010 and 2014. That's almost 2 outlets per hour 365 days a year.

As a potential Franchisee, your due diligence job is to find a great franchise investment, provide for your family and grow your business. While that is certainly your ultimate goal when you invest into a franchise, for some franchisees that simply does not happen.

What happens when a franchise investment goes bad? What does a franchisee do when they begin to suspect that they’ve made a bad investment that turns out to be less than a dream. Then what?

Do you continue to dig in your heels, try and make it work, and hope for the best? What can you do to make the best of a bad situation? Perhaps the best place to start is to do a self-assessment.

1. Be Aware of Your Limitations

Tali Sharot has an enlightening video on optimism bias, which is an unrealistic belief that causes a person to believe they are less at risk to experience a negative event compared to others. Often, Franchisees greatly underestimate the risks of operating the business. In part, many "experts" write about franchising as a “can't fail” investment; that you are "in business for yourself, not by yourself". These statements are at best misleading and at worst, outright false.

2. Determine If Your Investment is a “Sunk Cost”

A sunk cost is defined as any past cost that has been paid for and cannot be recovered. Consider this definition from Investopedia: "There's an old saying that you shouldn't throw good money after bad. It's founded in the common-sense principle that just because you've spent money on something up to a point, there's no reason to keep spending money on it if the chances of recovering your investment are doubtful."

For some franchisees unfortunately, your investment into the franchise may be a sunk cost. How do you determine if your investment is or is not? Ask yourself:


  • Is there a chance of recouping your investment?
  • Is your business profitable?
  • Are you able to make enough money to pay off debt?
  • Can resell your franchise for a reasonable price?

If your answers to these questions are no, your investment may be a sunk cost and as the saying goes: You shouldn't throw good money after bad. If you are in a franchise that is a sunk cost, it’s time to consider your next move: Deciding what is best for you and your family going forward. It might mean admitting failure - a hard thing to do for sure, but better than continuing to throw good money after bad.

3. Take Control of Your Fate

As defined by David McRaney in his You Are Not So Smart blog, "If you feel like you aren’t in control of your destiny, you will give up and accept whatever situation you are in." Mr. McRaney also states that "Any extended period of negative emotions can lead to you giving in to despair and accepting your fate."

This despair, feelings of helplessness, negative emotions, etc. are prevalent in various blogs and chat rooms like Unhappy Franchisee and BlueMauMau: Feedback from Franchisees upset about their situation that resort to posting anonymous (largely negative) comments.

This effect is most commonly defined as learned helplessness.

Now What?

If you assess your situation and feel you have made a bad investment decision, you need to find a way to prevent further losses, both in your financial and personal life. Speak with a lawyer and start taking steps to fix your situation.

Lesson for Prospective Franchisees

Prospective franchisees need to be aware that there are risks and that these situations are happening now to investors just like you, every hour of every day.

Taking time and investing money up front to perform extensive due diligence, paying for legal support and expert advice and ensuring you do all you can to avoid potential investment mistakes can make all the difference between a dream and a nightmare.

There are excellent franchise investment options available for prospective franchisees. But both good and bad investments exist in the industry. Knowing how to differentiate between them take time, energy and money.