How to Check a Franchisor’s Finances and Business Continuity Before Joining in Japan

Joining a franchise means choosing not just a brand, but a long-term business partner. Even if your own outlet performs well, financial difficulties at the franchisor could disrupt your use of the trade mark, payment systems and other services. Before signing a contract, check the franchisor’s finances and its ability to keep operating so that you can join a financially sound franchise network.

1. Understand the disclosure rules and identify the company to investigate

Japan has no single, comprehensive law governing all franchises. However, Article 11 of the Act on the Promotion of Small and Medium-sized Retail Business requires franchisors operating a “specified chain business”, as defined in that Act, to provide prospective franchisees with written disclosures and explain them before a contract is signed.

Whether a business falls within this category depends on how it operates, not what it calls its brand. The criteria include having mainly small and medium-sized retailers as members; providing ongoing product sales or sales intermediation and management guidance under standardised contracts; and making contractual provision for matters such as the use of trade marks and payments on joining. Even in retail sectors, including food service, you should not assume that a business is covered based on its description alone.

Disclosures required from franchisors covered by the Act include balance sheets and profit and loss accounts for the three most recent financial years, changes in the number of franchised outlets, and the number of lawsuits relating to franchise agreements. Start by asking: “Please provide the disclosure document for the legal entity that will be my contracting party, and explain its contents.”

Even where this disclosure requirement does not apply, the Antimonopoly Act applies to dealings between franchisors and franchisees, who are independent businesses. The Japan Fair Trade Commission’s guidelines on franchise systems under the Antimonopoly Act set out information that should preferably be disclosed before signing across a wide range of franchise sectors. Distinguish this guidance from the statutory duty to provide written disclosures under Article 11 of the retail business Act. General laws, including the Civil Code, also apply to contracts.

Once you receive the documents, identify the following parties:

• The legal entity entering into the franchise agreement
• The recipient of the initial franchise fee and security deposit
• The owner of the brand’s trade marks
• The legal entity providing payment and outlet management systems

A well-known parent company does not guarantee that the entity you contract with can meet its payment obligations. Check information about that entity itself, rather than relying solely on material describing the wider group.

2. Read the financial statements by separating profit, cash and borrowing

When reviewing financial statements, do not focus solely on the size of turnover. A profitable business can still run short of cash if payments fall due before money comes in. Equally, a temporary loss does not necessarily mean that the business cannot continue.

Use the profit and loss account to check profits from core operations and where they come from. Compare trends in turnover and operating profit. If turnover is rising but profit is falling, ask why. Also distinguish profits from exceptional transactions, such as asset sales, from those generated by ordinary business activities.

Pay particular attention to the balance between one-off income from new franchisees and recurring income from existing outlets. Ask whether the franchisor could maintain support and services for existing outlets if recruitment slowed. If the financial statements do not provide this breakdown, request further explanation. Bear in mind, however, that not every document you request is subject to a statutory disclosure requirement.

Use the balance sheet to compare cash and bank balances with near-term payment obligations. If short-term borrowing or trade payables are increasing, or net assets are declining, ask about the reasons and the measures being taken. Even a large cash balance may not represent money freely available to spend if it is needed for repayments or refunds.

Specific questions can help you obtain useful explanations:

• Has borrowing increased to fund new outlets, or to cover day-to-day working capital?
• Are any major repayments or fundraising arrangements planned?
• If there are loans to related companies, when are they expected to be repaid?
• Have there been any significant changes in the financial position since the latest financial year-end?

Where possible, also request a recent trial balance and an explanation of the cash-flow position. If you are unsure how to assess the figures, consult a Japanese certified tax accountant or certified public accountant before signing.

3. Cross-check outlet numbers and litigation information against the financial explanations

Growth in outlet numbers alone does not establish a franchisor’s stability. If many outlets are closing while others open, the network may be experiencing continual turnover.

For the trends disclosed, look beyond the total at each year-end. Check the breakdown of new openings, closures, contract terminations and conversions to company-operated outlets. The number of franchised outlets and the number of franchisee businesses are also different measures. If one franchisee operates several outlets, growth in outlet numbers does not necessarily mean that the franchisee base is expanding.

When comparing figures, make sure the reporting periods and scope match. You cannot directly compare a document covering only franchised outlets in Japan with another that includes overseas and company-operated outlets. Do not immediately treat discrepancies as evidence of wrongdoing: first ask whether the definitions differ.

The number of lawsuits is not, by itself, a measure of whether a franchisor is a good business partner. Check whether the franchisor or franchisee brought each case, what the main issues were, and whether similar problems recur. An absence of lawsuits does not prove that there have been no disputes.

If possible, speak to existing franchisees with the franchisor’s agreement. Ask about recent operating conditions: for example, whether responses to enquiries have become slower or their contact person changes frequently. Rather than treating individual complaints or online reviews as established facts, use them to frame further questions for the franchisor.

4. Check how difficulties at the franchisor could affect your outlet

Financial due diligence is not about predicting insolvency. Its purpose is to understand what your outlet depends on if problems arise.

Start by mapping the flow of sales proceeds. The implications differ depending on whether customer payments go directly to the franchisee or are first received by the franchisor and then transferred. If funds pass through the franchisor, check how long transfers take, how the money is managed, and what happens if a transfer is delayed.

For any security deposit paid when joining, ask not only about the conditions for repayment but also whether safeguards are in place to protect it. A contractual promise to repay a deposit is not the same as being able to recover it in full if the franchisor’s financial position deteriorates.

Next, list the functions essential to running your outlet.

Function to check	Questions for the franchisor
Use of trade marks	Who owns the rights, and what authority does the franchisor have to permit their use?
Payment and booking systems	Who is the contracting party, and are there procedures for dealing with service interruptions?
Outlet data	What data can the franchisee access and export?
Settlement of sales proceeds	Do any funds pass through the franchisor, and who should be contacted if transfers are delayed?

If the franchisor becomes insolvent, you may not automatically be entitled to continue using the brand or systems. Continued use and the treatment of contracts depend on matters such as ownership of rights, contract terms and insolvency proceedings. Rather than making these judgements yourself, ask a lawyer to review critical dependencies.

5. Resolve outstanding questions and document your decision

Finally, organise your findings into a table covering “points checked, supporting documents, the franchisor’s answers and unresolved issues”. After meetings, put verbal explanations in writing and ask the franchisor to confirm that you share the same understanding. If an explanation conflicts with a document, do not rely on the explanation alone: request a correction or supplementary information for the relevant document.

If the franchisor is subject to statutory disclosure requirements but does not provide the documents or explanations, do not dismiss this as a simple lack of information. Consult a support service, such as one provided by Japan’s Small and Medium Enterprise Agency, or a lawyer. On the other hand, failure to provide optional additional documents is not, in itself, unlawful. Consider whether an alternative explanation adequately addresses your concerns.

Even if you are urged to sign or pay quickly, defer your decision while major questions remain unresolved. Receiving a disclosure document does not amount to an official guarantee of the franchisor’s financial health.

Key practical point: review the contracting entity’s financial statements, changes in outlet numbers and the flow of your outlet’s funds together. Decide whether to join only once you have satisfactory explanations for changes in the figures and understand how a shutdown could affect your business.