Buying a franchise: checking the franchisor’s financial strength

Joining a franchise network requires trust, but brand recognition does not prove the financial health of the company you will be contracting with. Before investing, you need to establish whether the franchisor has the resources to meet its commitments. This check does not replace an assessment of your prospective outlet: it evaluates the risk of relying on a financially weak partner.

1. Identify the company taking on the obligations

Start with the legal name, corporate identification number and registered office of the entity that will be named in the agreement. A well-known brand may be operated by several companies, and the business introduced at meetings may not be the one taking on obligations towards you.

Ask for the permanent commercial registry certificate (certidão permanente do registo comercial), or its access code, and confirm who has authority to bind the company. Check its registered status, governing bodies and any significant changes, such as frequent changes of management or registered office. These changes do not prove financial difficulties, but they warrant questions.

If you are negotiating with a representative of an overseas network, clarify:

• Which Portuguese or overseas entity will enter into the agreement with you?
• What is the relationship between that entity and the company running the network?
• Who receives payments, and who is responsible for fulfilling the contractual obligations?
• Is there a written guarantee from the parent company, or merely a reference to the group in sales materials?

A group’s consolidated accounts are no substitute for the accounts of the company you will be contracting with. A local company may have limited resources even if it belongs to a large organisation.

2. Request accounts and assess the ability to keep operating

Request financial statements for the latest available financial years, including the balance sheet, income statement and notes to the accounts. Where available, also ask for the management report and statutory auditor’s report. If a substantial period has passed since the latest financial year-end, request interim accounting information, clearly identified as provisional.

Use a certified accountant to help interpret the documents. The aim is not to find a single indicator that gives the investment a pass or fail, but to understand how the company’s financial position is developing.

Pay particular attention to:

• Equity: accumulated losses may reduce the company’s capacity to absorb further setbacks.
• Liquidity: accounting profits do not necessarily mean cash is available to meet upcoming commitments.
• Debt: repayments falling due close together and reliance on short-term finance can put pressure on cash flow.
• Balances with related companies: amounts owed by other group companies may not be readily convertible into cash.
• Audit qualifications or uncertainties: where the accounts have been audited, ask for clarification of any references to the company’s ability to continue as a going concern.

For a recently established company, the lack of a track record does not prove that the business is unviable. It does, however, call for greater clarity about available funding and the shareholders’ actual commitments.

3. Distinguish network growth from sustainable revenue

Ask where the franchisor’s revenue comes from: company-owned outlets, recurring payments from the network, supplies or new franchisees joining. At this stage, you are not checking how each charge is calculated, but how financially dependent the company is on new recruits.

Rapid growth may require recruitment, systems and investment before it generates sufficient revenue. If the company relies mainly on opening new outlets to cover day-to-day expenses, a slowdown could undermine its ability to meet its obligations.

Request a documented explanation for significant changes in revenue and financial results. Establish whether profits come from normal trading or one-off events, such as the sale of an asset.

Compare this analysis with the number of outlets opened, closed and transferred to new owners. An isolated closure may have local explanations; a pattern deserves investigation. Speak to current and former franchisees about specific warning signs, such as delayed reimbursements or interruptions to contracted services, without treating individual accounts as conclusive evidence.

4. Understand what information you can require in Portugal

Portugal has no specific law comprehensively governing franchise agreements, nor a mandatory pre-contractual disclosure document with content and deadlines specific to franchising. There is also no dedicated register of franchisors that certifies their financial strength.

General rules apply, notably those in the Portuguese Civil Code: Article 405 provides the framework for freedom of contract, while Article 227 requires good faith in negotiations. Withholding relevant information or providing false information may give rise to liability, depending on the circumstances. This does not amount to an unrestricted right of access to all internal documents.

Where standard contract terms are used, Decree-Law No. 446/85 also applies, including duties to communicate terms and provide information. The franchising sector’s codes of ethics neither replace the law nor guarantee solvency.

5. Turn concerns into conditions for proceeding

Request up-to-date certificates confirming that the company’s tax and social security obligations are in good standing. These are useful, but they do not demonstrate the absence of all debts. Also request information on significant litigation, financial defaults and insolvency or restructuring proceedings, and arrange independent legal checks.

Keep a record of requests, responses and documents received. Where there are legitimate confidentiality concerns, suggest restricted access for your advisers. A refusal without a reasonable alternative leaves a risk unresolved.

Practical conclusion: before signing, gather the company’s identification details, accounts, explanations of its debts and evidence of its revenue sources. Ask your accountant and lawyer for a joint assessment. Do not proceed while a material financial concern rests on a verbal assurance alone.