Buying a franchise: assessing the franchisor’s finances

When you buy a franchise, you become part of a network, but you also become financially dependent on the company behind the concept. If the franchisor struggles to pay its bills, shared systems, supplies and other central functions may be affected. Your due diligence should therefore go beyond the financial projections for your own outlet. Here is a practical approach to assessing a franchisor’s financial resilience before you commit capital.

1. Identify the company you will actually depend on

Start with the company registration number of the business that will be your contractual counterparty. A well-known brand may be represented by a small Swedish company, while other companies in the group handle invoicing, technology or administration. The size of the group therefore does not automatically tell you whether your counterparty can meet its payment obligations.

Ask for a simple overview of the corporate structure showing:

• which company will sign the franchise agreement,
• which companies receive the initial fee and ongoing fees,
• which companies are responsible for critical shared functions,
• whether your counterparty depends on loans or capital injections from its owners.

Check this information against company registry records and annual reports. If the Swedish company operates under an agreement with an overseas master franchisor, you also need to understand that relationship and its financial significance.

In particular, ask what happens if a related company stops funding the business. A verbal assurance that “the group is behind us” is not the same as a binding commitment. Ask a lawyer to assess any guarantees and establish which party you can actually require to fulfil the obligations under your agreement.

2. Read the figures as a prospective business partner

Request the latest available annual reports, ideally covering several years. Supplement these with an up-to-date profit and loss statement and balance sheet if the annual report no longer gives a fair picture. Requesting these additional documents is part of your due diligence; you do not have a general right to access internal accounting records.

Ask an adviser with accounting expertise to help you understand the trends. Focus on four questions:

Does the company make money from its ongoing operations? Distinguish recurring income from one-off items, such as asset sales. Otherwise, a profit may give a misleading impression of the business’s financial sustainability.

Is there enough cash to pay the bills? Profit and liquidity are different things. Large amounts owed by customers can leave even a profitable company short of cash when wages and suppliers need to be paid.

What does its debt position look like? Examine short-term loans, debts to related parties and any substantial repayments falling due soon. Ask how the business plans to fund itself in future.

Are there any qualifications or uncertainties? Read the directors’ report, the notes to the accounts and any auditor’s report. Disclosures about going concern, late annual reports or repeated capital injections warrant further questions. The absence of an auditor is not, in itself, a warning sign: smaller Swedish limited companies can opt out of an audit under certain conditions.

A credit report can help complete the picture. Always consider how recent the information is and its context, and give the franchisor an opportunity to explain discrepancies before drawing conclusions.

3. Check whether the finances depend on constant recruitment

An important distinction is whether the franchisor mainly funds shared functions through recurring income from operating outlets or through fees from new franchisees. Initial fees are not inherently problematic, but heavy dependence on continuous expansion can make the network vulnerable.

Ask for a broad breakdown of initial fees, ongoing franchise fees and other significant income. Then ask which costs would remain if no new outlets opened for a period.

Also put specific questions to current and former franchisees:

• Have shared services or systems suffered repeated interruptions?
• Have agreed payments or credits been delayed?
• Have payment terms changed unexpectedly, or have new demands for advance payment been introduced?
• Have key contacts at head office left without effective replacements?

An isolated incident does not necessarily indicate financial problems. Look for recurring patterns and compare the answers with the franchisor’s explanation.

Next, carry out a stress test with your adviser: what costs would your outlet face if a central function became temporarily unavailable? For example, estimate the cost of alternative administrative support or a brief interruption to trading. The aim is not to predict bankruptcy, but to understand how much cash you need in reserve to manage this dependence.

4. Link your due diligence to the law and your payments

Sweden has no single comprehensive law governing the entire franchise relationship. However, the Franchisors’ Disclosure Obligations Act (2006:484) applies. Under section 3, the franchisor must provide clear, comprehensible written information about the implications of the agreement and other relevant circumstances in good time before it is signed. The minimum disclosure requirements include fees and other financial terms.

The Act does not impose an explicit general requirement to provide audited annual reports or internal financial reports. Treat your financial due diligence as a separate basis for your decision, rather than something automatically completed once the disclosure materials have been supplied. General contract law, including the Swedish Contracts Act (1915:218), is also important.

If your checks reveal uncertainty, discuss staged payments linked to clearly defined deliverables rather than large upfront payments. Ask a lawyer to assess possible security arrangements and repayment terms. A contractual promise to repay offers limited help if the recipient has no money; effective protection requires more than wording alone.

Practical takeaway: Identify the right company, examine both its financial history and current position, and test its dependence on new openings. Do not make a substantial advance payment until significant questions have been resolved and any protective arrangements have been documented.