Business 20 tips to avoid buying a ‘zombie’ franchise Ana LopezNovember 24, 20220190 views Opinions expressed by businessroundups.org contributors are their own. Zombie franchises exist. What is a Zombie Franchise? It’s one that’s stalled, but still markets its franchise opportunity as if nothing happened. The brand tends to shrink, both in terms of relevance and number of open units. Previously loyal customers are being sucked away by more innovative concepts. Underlying demographics may have shifted. Market trends may work against the brand, but management has not broken new ground. The unit-level economy is weakening. Management inertia or denial can exacerbate the brand’s problems. Zombie franchise systems are usually filled with franchisees who would gladly leave if only they could! Poor unit-level economics and an undercurrent of dissatisfaction among franchisees are driving buyers away, resulting in low resale volumes. Expansion-oriented franchisees look beyond the brand. Related: 5 strategies to avoid the most common franchisee mistakes Don’t get caught 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 feedback. They may remember 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 this destroys the trust of the franchisee and usually the relationship. Franchisees in a zombie system are typically chained to the business with personal guarantees, a site lease, equipment or vehicle lease, a Small Business Administration (SBA) loan, a loan for their home, a loan for 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, sell the business, and shut it down. They are essentially indentured servants. Often these brands spend a lot of money on branding and advertising to convince potential franchisees that they are still worth an investment. They are trying to revive 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 are a founder hoping to sell to private equity, PE will exclude brands with these characteristics unless they are dedicated turnaround investors, so solving these issues becomes your to-do list: Lack of growth per unit, 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 suggest moving on. Weak unit-level profitability Development agreements that have not been fulfilled. Franchisees would rather lose their deposits than go ahead and open promised units. Item 20 in the Franchise Disclosure Document lists franchisees and development agreement holders. Connect with those franchises. Parent company overly dependent on franchise sales. See how much revenue is related to franchise fees compared to recurring royalty income. Parent company paying more attention to the supply chain and discounts to generate revenue, again usually a signal of falling recurring royalties. Dark revelations about franchise discounts and supply chain costs should also encourage you to move to other concepts. Bloated sold not open (SNO) funnel or SNO numbers quietly adjusting from year to year due to weak unit openings. Google press releases from last year and industry articles. Was management bragging about “400 units sold” five years ago, but only 50 units are open and the rest are still on the item 20 sold not open list? Red flag. An increasing number of underperforming franchises. Again, it’s worth tracking down old revelations so you can compare several years of unit-level performance. How resilient is the concept? Are trends positive? The franchise will stop publishing Item 19 earnings representations when Item 19s were routinely included in previous disclosures. Increased franchisee lawsuits Franchisees who want to sell before their first license agreement expires. Potential franchisees drop out after considering resale options. Franchise dissatisfaction spreads to Internet sites devoted to publishing stories of unhappy franchisees. During validation, you discover that franchisees are not following the system. They have developed “hacks” to improve profitability. Poor franchisee validation, poor franchisee surveys, or other signs of a dysfunctional franchisee-franchisor relationship. Shrinking candidate funnel weakening customer interest; falling market share. Company team turnover, especially among field workers (they are the staff members who work most closely with potentially unhappy franchisees). Do franchisees give positive marks to the performance of the management team? Do you see danger signals but management seems to deny? Self-righteous? Blame franchisees? Has anyone on the corporate team ever left to become a franchisee themselves? Why not? Is there evidence of continued investment in innovation to keep the brand relevant? Do franchisees say this is a problem area? Relatively high mortgage costs for Small Business Administration (SBA). These are lagging indicators over time, but certainly a worrying signal. Related: What You Should Really Look For When Considering a Franchise Can you work through the list above? Sure! You owe it to yourself to conduct proper due diligence. The list above will save you time, money and headaches. If you see weak signals, don’t waste your time. Just keep going. There are many strong, healthy, proven franchise options out there. Be picky and protect your time and money. Only the most valuable concepts deserve your attention and commitment. What if you’re a franchisor and you recognize disturbing signals from your own brand in this list? Start improving the unit-level economy and restoring trust and strong communication with your franchisees. Those are the two areas of greatest impact in any franchise. Are you interested in eventually selling your franchise business to private equity? Preventing problems is key in the first place. Any hint of trouble can have a major impact on your deal terms, company valuation, and even which investors will be seriously interested in your brand. Once you’ve fallen out, the bar is raised to prove you’re back on track. Remember, most franchising PE investors want a growth story, not a turnaround project. Are you building a valuable reputation?