Buying a franchise: check the franchisor’s financial health

Buying a franchise means joining a community of interdependent business owners. That makes the financial prospects of your own outlet only part of the picture: the franchisor must also be able to meet its obligations. A well-known name or a growing number of locations is no proof of this. Targeted checks will help you establish whether the franchise network is backed by a financially stable organisation.

1. Establish which company you are dealing with

The brand name above the door is not always the name of the company you will be contracting with. Within a group, the brand, franchise agreements, supplies and IT systems may sit within different companies. A financially healthy parent company does not automatically mean that the company you sign with has sufficient resources.

Ask for a simple group structure chart and check the legal name and Dutch Chamber of Commerce (KVK) registration number in the draft agreement. Then establish:

• Which company receives your initial franchise fee and ongoing fees?
• Who owns the brand, and who is authorised to license its use?
• Which company provides essential services or products?
• Is there a guarantee from another group company, and what exactly does it cover?

Check the company’s entry in the Dutch Business Register and review its filed annual accounts, where available. KVK registration is not a quality mark or proof of financial health. Nor does the Netherlands have a separate statutory franchise register that guarantees the reliability of a franchise business.

2. Request financial information under the Dutch Franchise Act

The Netherlands has specific franchise legislation: the Dutch Franchise Act (Wet franchise), incorporated into Title 16 of Book 7 of the Dutch Civil Code. Among other things, Article 7:913 requires the franchisor to provide information about its financial position before the agreement is concluded. Its disclosure duty also covers information that it knows, or can reasonably be expected to suspect, is relevant to your decision.

This does not mean you are automatically entitled to every internal document. Be specific in your requests and explain why you need the information for your assessment.

For example, ask for recent annual accounts, an explanation of significant debts and up-to-date interim figures if the latest annual accounts no longer give a representative picture. Also ask about events after the balance sheet date, such as the loss of a major source of finance or a substantial payment obligation.

The law also requires you, as a prospective franchisee, to take reasonable steps to avoid signing on the basis of incorrect assumptions. Simply receiving documents is therefore not enough: ask follow-up questions, compare explanations and have any uncertainties investigated. Keep written records of the answers in your purchase file.

3. Have the figures assessed for financial sustainability

Ask an independent accountant or financial adviser not just to establish whether the business has made a profit, but above all to assess whether the franchisor can continue to fund its operations. Request a comparison across several financial years, where figures are available.

Four areas deserve particular attention:

• Liquidity: are sufficient funds available to meet short-term obligations?
• Equity: how much scope is there to absorb losses?
• Cash flow: do ordinary business activities generate cash, or does funding mainly come from new loans and capital injections?
• Dependencies: does the organisation rely heavily on a single lender, supplier or group company?

A business can report a profit while facing a cash shortage. Conversely, a loss-making year does not necessarily mean that a franchise business is unsustainable, for example if there is clear evidence of investment and its funding is secured.

Ask for explanations of any unusual items. These might include large amounts owed by group companies, exceptional income or sharply rising debt. Do not use a single financial ratio as an automatic pass-or-fail threshold: the overall picture and current circumstances determine the risk.

4. Investigate whether growth is masking financial weakness

New outlets can generate initial franchise fees, but they also create additional costs. Investigate whether the organisation can sustain its operations on income from existing franchisees, or whether it continually needs new franchisees to cover day-to-day expenditure.

Ask how income from new franchisees compares with recurring income. Request an explanation of the costs associated with each. A rapidly expanding franchise network should be able to explain how it pays for staff, systems and central support services.

Also speak to existing and, if possible, former franchisees. Ask about specific experiences: are refunds paid on time, do suppliers honour their commitments, and have there been unexpected requests for advance payment? One complaint proves little. Recurring concerns, however, call for a substantiated response from the franchisor.

5. Record your decision and conditions

Before signing, draw up a summary with three columns: established facts, missing information and required solutions. Discuss material uncertainties with your accountant and a lawyer specialising in franchising.

For large advance payments, for example, you could ask to spread the payments or obtain appropriate security. If the business depends on another group company, have an adviser assess whether a guarantee would offer effective protection. Do not assume that a contractual clause can shield you from every consequence of financial difficulties or bankruptcy.

Practical conclusion: sign only when you understand who you are contracting with, how that company is funded and what supports your confidence in its ability to keep operating. If essential information is still missing, postpone your decision.