Buying a Franchise: Check the Franchisor’s Finances

When you buy a franchise, you join a network in which your business depends on the franchisor’s ability to keep the operation running. Your due diligence should therefore go beyond your own budget. You also need to understand the finances behind the network’s head office: who are you contracting with, where does the money come from, and what happens if the franchisor comes under financial pressure?

1. Identify the company behind the franchise agreement

A well-known name does not necessarily mean a financially strong contracting partner. A franchise network may comprise several companies: one may own the rights, another employ the staff, and a third enter into franchise agreements.

Start by finding the exact company name and CVR number in the draft agreement. The CVR number is the company’s Danish business registration number. Check these details against Denmark’s Central Business Register (CVR), and review the company’s status, management, ownership and available annual reports. If the contracting party is based outside Denmark, use the relevant business register in its home country.

Then ask for a simple overview of the companies and their roles:

• Which company receives your initial fee and ongoing royalties?
• Which company employs the staff who will support your operations?
• Which company owns or controls key systems and franchise materials?
• Does the contracting party depend on funding from its owners or other group companies?

A strong parent company is not automatically liable for a subsidiary’s obligations. If the franchisor emphasises the group’s financial strength, ask what this means in practical terms for your agreement. A letter of support is not necessarily the same as a binding guarantee either; have a lawyer assess the wording.

2. Review the finances over several years

Ask for the latest available annual reports, ideally covering several years. The aim is not to find one impressive profit figure, but to understand the trend. Get an accountant’s help if you are not comfortable reading accounts yourself.

Pay particular attention to equity, liquidity and debt. Positive equity does not necessarily mean the company has enough cash to pay its next bills. Profits may also be tied up in receivables or reflect one-off items.

Check whether the auditor has qualified their opinion or highlighted any material uncertainty about the company’s ability to continue as a going concern. An unaudited annual report is not a warning sign in itself, but you should understand the difference between information supplied by management and information that has been audited.

The annual report describes the past. Ask for more recent management accounts or a written update on significant changes since the balance sheet date. These might include the loss of major revenue streams, new debt or a need for additional capital.

Ask for explanations of large fluctuations. A weak year may reflect a planned investment; repeated losses without funding require a different assessment. Do not simply accept the answer that ‘the owners are backing the business’. Ask whether the funding has actually been agreed, on what terms and for how long.

3. Find out what funds the network

The franchisor’s sources of income can tell you something about the resilience of the relationship. Ask for a breakdown of income from initial fees, ongoing royalties, company-owned outlets and any other sources.

The key question is: Can the franchisor maintain the organisation it needs if no new franchisees join for a while?

Heavy reliance on new initial fees can leave the business financially vulnerable. This is not proof of problems, but it should prompt further questions about funding and costs. Also check whether the budget assumes a large number of new openings that have not yet been agreed.

Speak to current and former franchisees about specific observations. Have key staff left without being replaced? Have network-wide projects been repeatedly postponed? Have there been unusual requests for advance payment? Individual accounts should be checked, not treated as documented evidence of financial problems.

Summarise your findings in a short table with three columns: information, supporting evidence and unanswered questions. This makes it easier to distinguish facts from explanations and sales pitches.

4. Understand the rules and set your conditions

Denmark has no specific franchise law, no franchise-specific registration scheme and no legally required standard pre-contract disclosure document. The usual business registration requirements still apply.

Franchise agreements are governed primarily by the Danish Contracts Act and general principles of contract law. Section 36 of the Contracts Act allows unfair agreements to be varied or set aside, but it is no substitute for thorough due diligence. The Danish Marketing Practices Act and Competition Act may also be relevant.

The absence of specific disclosure requirements does not mean that franchisors are free to provide false information or conceal material facts. Depending on the circumstances, general legal principles concerning good-faith disclosure and mistaken assumptions underlying an agreement may be relevant. A lawyer should assess the particular situation.

Agree in writing which financial information you will receive before signing a binding agreement or making a payment. Also consider securing a contractual right to receive financial information on an ongoing basis. If essential supporting documents are missing, put the purchase on hold until the position is clear.

Practical takeaway: Identify your contracting partner, have the finances assessed, and require evidence of the funding on which the relationship depends. A strong franchise network should be able to withstand reasonable questions about its financial foundations.