Franchising: assessing a franchisor’s financial strength

Joining a franchise network means entrusting part of your business’s operational continuity to another company. A recognisable brand is no guarantee that the franchisor has the resources needed to maintain its services, technology and organisational infrastructure. Before investing, you therefore need to assess not only how much your outlet might earn, but also the financial strength of the company you will be signing the agreement with.

1. Identify the company and request its accounts

Start by checking the legal name and Italian tax identification number of the franchisor named in the proposed agreement. The trading brand, the company recruiting new franchisees and the company signing the agreement may not be the same. Even if they belong to the same group, one company’s results do not automatically demonstrate the financial strength of the others.

In Italy, franchising is governed by Law No. 129 of 6 May 2004. Article 4 requires the franchisor to provide the prospective franchisee with a complete copy of the agreement and the required supporting documents at least thirty days before signing. The information includes key details about the franchisor and, at the prospective franchisee’s request, accounts for the previous three years, or since the business began trading if that was more recent.

Submit a written request for the full accounts available, rather than relying on a presentation showing turnover and the number of new openings. Where accounts have been filed, compare them with those available from Italy’s Business Register (Registro delle imprese). Ask your accountant to examine the notes to the accounts and any reports from the company’s supervisory bodies or auditor as well.

If the business is new, the lack of a long track record does not mean it is unreliable. It does, however, make it more important to understand its available capital, financing and existing commitments.

2. Look at earnings, equity and cash together

Growing turnover is only a starting point. To assess the company’s ability to support its franchise network, you need to consider at least four aspects together:

• Profit or loss: does the company make a profit or accumulate losses? Does its performance reflect ordinary trading or one-off transactions?
• Equity: is there an equity cushion capable of absorbing further losses? Have shareholders repeatedly had to provide support?
• Debts: what amounts must be repaid in the short term, and to whom? Bank borrowing and debts owed to suppliers have different operational implications.
• Liquidity and cash flow: does the business generate enough cash to meet its obligations, or does it depend on new financing?

Profit and available cash are not the same thing. A company may record revenue before collecting the corresponding payments. This is why you should also look at how trade receivables are changing relative to sales.

Not all accounts include a cash flow statement: certain categories of company are exempt. If one is missing, ask your accountant what further information is needed. Avoid universal thresholds or judgements based on a single ratio: trends over time, the operating model and actual payment deadlines all matter.

3. Understand how much the franchisor depends on new openings

The central question is simple: can the franchisor support its organisation through the performance of existing businesses, or does it need to keep recruiting new franchisees?

Where possible, ask for a breakdown of revenue from initial franchise fees, royalties, supplies, services and company-owned outlets. The accounts may not provide this level of detail, so you will need to request a further explanation. Do not assume, however, that every breakdown you would like to see is a legally required supporting document.

A high proportion of revenue from initial fees is not, in itself, evidence of financial weakness. It does warrant closer scrutiny if it comes alongside losses, limited cash and rising organisational costs.

Also compare financial performance with changes in franchisee numbers and the presence of company-owned outlets. Growth in new openings alone does not tell you how many businesses remain operational or how much they contribute to recurring revenue.

Ask a specific question: ‘If recruitment of new franchisees slowed, what resources would keep essential services running?’ Look for answers consistent with the figures, rather than simple reassurances about brand recognition.

4. Turn concerns into clear decision criteria

Before signing, work with your accountant to prepare a short summary covering each finding, the potential risk, the clarification requested and the response received. For example, an increase in amounts owed to suppliers requires an explanation of whether it reflects growth or difficulties making payments.

Accounts describe past periods. If the latest available financial year ended well before the proposed signing date, ask for updated information on performance, liquidity and significant events. Always distinguish between management figures and formally approved accounts.

Where business continuity depends on support from a parent company, ask your lawyer to check whether a binding commitment exists and what it covers: membership of a group is not equivalent to a guarantee.

Practical advice: before investing, obtain the accounts, have them reviewed by an independent professional and seek written clarification of significant anomalies. If doubts remain about the franchisor’s ability to meet its commitments, postpone your decision.