Is Investing in a Franchise Worth It? A Buyer’s Guide to Due Diligence

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• Wall Street firms may soon be able to pay for a market advantage on Trump Social.
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Owning your own business sounds exciting. Building one from scratch? Less so.

That’s why franchising can seem like a tempting shortcut for many aspiring business owners. Instead of inventing the next McDonald’s, you can simply buy into the franchise. The brand already exists, and someone else has tested the menu and created all the recipes. It’s entrepreneurship with an instruction manual already written for you. All you need to do (not really– it’s more complicated than that) is pay the fee to use it.

But the reality is that not all franchises are success stories. Some are total scams, while others create multi-millionaires. And then there’s everything else in between.

Do Franchises Really Have Higher Success Rates?

One of the industry’s most persistent selling points is the mantra that franchises succeed at far higher rates than independent businesses. But the evidence is much more nuanced.

You may have heard claims that franchises have a 90% success rate, or that they’re dramatically less likely to fail than other small businesses. But you should know that stats like these are an industry myth. We discussed this in 5 Important Considerations for Aspiring Franchise Investors, which traces the 90% figure back to a 1987 IFA report that the IFA itself later urged members to stop citing.

Part of the problem is that it’s unclear how success is measured. A business might still be operating five years later but have earned little for its franchisee. Simply surviving isn’t the same as succeeding.

But loan default data does offer a useful metric.

Small Business Administration 7(a) loans are the most common form of financing used for franchise purchases. PeerSense analyzed more than 1.28 million resolved SBA loans and found that franchises have lower SBA loan default rates than independent businesses in only 41 out of 99 industries. In the remaining industries, independent businesses performed as well, or better.

If we look below that single statistic, there is also significant variation across different industries.

Industry	Franchise Default Rate	Overall Business Default Rate
Limited-service restaurants	17.3%	18.9%
Personal care franchises	12.7%	17.5%
Truck transportation franchises	8%	16.6%
Professional/technical services	16.3%	13.4%
Repair and maintenance	20%	14.4%
Food and beverage stores	18.9%	16.2%

Source: PeerSense.

There are plenty of franchises that outperform independent businesses. But the data shows that choosing the right franchise to invest in is essential.

How Do You Find the Numbers, and Can You Trust Them?

Franchising in the US is regulated primarily at the federal level by the Federal Trade Commission (FTC) under the FTC Franchise Rule, a pre-sale disclosure regulation first issued in 1978 and most recently revised in 2007. The FTC states that the Rule doesn’t tell a franchisor how to run its business or cap what it can charge. Instead, it requires franchisors to give prospective buyers a standardized packet of information called the Franchise Disclosure Document, or “FDD,” before any money changes hands.

The FDD is organized into 23 numbered “Items” covering topics such as the franchisor’s litigation and bankruptcy history, the fees you’ll owe, restrictions on suppliers and territory, training and advertising obligations, financial performance data, and the actual contracts you’ll be asked to sign. You are legally entitled to receive the FDD at least 14 days before signing any agreement or paying any money to the franchisor, and if a franchisor stalls, provides an incomplete document, or rushes you through it, that alone is a warning sign worth taking seriously. For more, read Franchise Fundamentals: Taking a deep dive into the Franchise Disclosure Document.

Some of the most consequential items are the ones you’ll see referenced throughout this article are:

• Item 3 (litigation)
• Item 7 (initial investment estimates)
• Item 19 (financial performance representations)
• Item 20 (unit-level growth, closures, and franchisee contacts)
• Item 21 (audited financial statements)

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What Actually Predicts Franchise Failure?

There are seven questions you should ask to help you spot whether a franchise may be failing.

1. Is this franchise system shrinking?

A shrinking franchise system is what VetMyFranchise calls “the single strongest predictor of future failure”.

A franchise system that opens 200 new stores in a year while closing 180 existing ones in the same year paints a bleak picture.

For these numbers, go to Item 20 of the FDD. This is an essential data point that includes statistical tables on the number of openings, closures, terminations, transfers, and total operating stores over the past three years.

Rather than looking at any one figure in isolation, prospective buyers should calculate the net change in units:

Net unit change = New units opened – Units closed, terminated, or not renewed

A negative result across several years indicates that the franchise system is losing stores faster than it can replace them.

2. Is there a high ratio of closures to openings?

Even if the number of store openings looks high and the franchise system is growing, there may still be an unhealthy level of turnover.

That’s why you need to look at the ratio of franchise closures to openings.

A good benchmark is 0.3, or 30 store closures for every 100 openings. Anything above that warrants deeper investigation.

3. How much income can a median franchise unit generate?

Item 19 of the FDD is where a franchisor provides data about the financial performance of its stores, including revenue, gross sales, costs of goods sold, operating expenses, or net profit.

It’s optional for franchisors to provide it, and about 60-65% of them do.

Item 19 is the only place where a franchisor can legally make claims about their financial performance, so if a sales rep is making big claims about how much revenue a franchise store can generate without disclosing their Item 19, that’s a major red flag.

The critical number to look at here is how much the median franchise store can generate after all expenses are paid.

When calculating, pay attention to what the report includes in expenses– you may need to factor in additional costs for an owner’s salary or capital expenditure.

Also note that the median is different from the average (or mean). A few high-performers will typically pull up the average number, which is why it typically looks more impressive than the median number. So, if a franchisor’s report only shows you averages, you may need to investigate further.

4. How does the franchisor earn its profits?

Item 21 of the FDD details the franchise system’s financial health and provides audited financial statements for the last three years.

For obvious reasons, it’s important to check that the franchisor is profitable. But what’s even more important is to understand how profits are being generated. Is the franchisor making more of its income from royalty payments from successful existing franchisees, or from the sale of franchises to other prospective franchisees?

In a healthy franchise system, most of the franchisor’s income should come from ongoing royalty payments from successful franchisees. But if a significant share of the franchisor’s income comes from selling new franchises, it may indicate a greater emphasis on expansion than on supporting their existing operators.

Subway is a useful case study here. In the 1990s and 2000s, the company focused on expanding aggressively, eventually becoming the world’s largest restaurant chain by number of locations. But years of aggressive development eventually hurt franchisees by cannibalizing existing stores.

The result is that hundreds of Subway stores have had to close, with total store count falling for a tenth straight year, in 2025. And that’s nothing compared to the total number over the decades. Watch this video presentation by a YouTuber; it’s short and excellent.

If you see signs of rapid expansion, question whether new franchise sales are strengthening the system or simply increasing the number of franchisees. A healthy franchise system should grow because the existing franchisees are doing well, and not because it constantly needs to recruit new ones.

5. Are there any repeated legal disputes?

Large franchise systems will almost certainly face the occasional lawsuit. That shouldn’t alarm you.

But you should investigate whether there is a consistent pattern of similar complaints.

Item 3 of the FDD discloses legal disputes with the franchisor. Repeated disputes over misleading earnings claims, excessive fees, inadequate support, or territory encroachment may point to deeper structural problems within the franchise system.

6. Can you actually afford the startup costs?

Item 7 of the FDD provides low and high estimates for the various costs of opening the franchise. Always use the high-end estimates as your baseline and add an additional 10-15% buffer for unexpected costs.

Even then, those estimates don’t always reflect what new franchisees are actually spending. Costs like accounting or legal help are often not included, and you also need to account for your personal living expenses.

Working capital, and the amount a new franchisee will need before starting to break even, is also often underestimated– the report may limit this to just 3-6 months, when in reality it may take a year.

One of the best ways you can test Item 7 estimates is to ask existing franchisees (listed in Item 20) how much they actually spent to open their business. If their answers consistently exceed the franchisor’s estimates, it’s a sign that you may need more capital.

The FTC recommends estimating your total operating expenses for the first year and your personal expenses for up to two years. This is crucial, as undercapitalization when entering the franchise system can be fatal, even if the underlying business model is sound. If you’ll need to borrow part of that capital, we discussed the tradeoffs among loan types in What Kind of Loan Makes Sense for Your Business?

7. Have you spoken to current and former franchisees?

The FDD can tell you a great deal about a franchise system, but it can’t tell you what it’s actually like to own one. That’s why the FTC suggests speaking with both current and former franchisees before you make an investment.

Current owners can tell you what it’s like to run the business today, and they can also offer you a clearer picture of startup costs, how long it took them to break even, and whether the business met their expectations.

Former franchisees can offer their perspective on why they chose to leave and whether they had any disputes with the franchisor.

Also consider speaking with franchisees at different stages of ownership. Someone who opened recently can tell you about the startup process and unexpected costs, while a long-term operator can explain whether the business has delivered the returns they expected over time.

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Who’s Watching the Franchisors, and Is It Working?

It’s Federal– But States Layer On More Protections

As we said above, franchising is regulated primarily at the federal level by the FTC, and it sets a nationwide disclosure floor, but roughly a dozen and a half states go further.

As stated in the USA chapter of the International Comparative Legal Guide to Franchise Laws and Regulations (the “Guide”), states including California, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, and Wisconsin require franchisors to register their FDD with a state regulator (and, in several of those states, obtain approval) before offering franchises there. Many of these states also have their own “franchise relationship laws” governing matters such as termination, renewal, and good-faith dealing, which can be more protective than federal law.

In practice, that means the strength of your legal protections as a franchisee can vary meaningfully depending on where you live and where the franchisor is registered to sell. A handful of states, including New York and California, also require pre-approval of franchise advertising materials and separate registration of the sales reps or brokers who pitch you.

Enforcement Has Real Teeth — But Limits

The Guide also explains that violating the FTC Franchise Rule is treated as an unfair or deceptive practice under the FTC Act, which authorizes the agency to sue franchisors in federal court, seek civil penalties, and obtain injunctions (including bans on selling franchises) and restitution for harmed franchisees.

But here’s the catch: there’s no private right of action under the federal Rule, meaning an individual franchisee generally can’t sue a franchisor directly for a Rule violation in federal court. Some state disclosure statutes do provide franchisees that right, along with remedies like rescission and damages, which is one more reason the state layer of regulation matters.

Enforcement has picked up in recent years. In February 2023, the FTC brought its first Franchise Rule case in 16 years, against fast-food chain BurgerIM and its owner, for allegedly making false promises and withholding required disclosures– a case that ended in permanent bans on selling franchises and tens of millions of dollars in judgments. Read more on recent actions in Issue Spotlight: Risks to Small Business Success in Franchising.

Franchisees Often Don’t Know Their Rights

A 2023 study published by the US Government Accountability Office found that many prospective franchisees don’t fully read the FDD, even though it contains information essential to their decision, and that franchise owners in eight of the nine discussion groups in its study said they were generally unaware of the FTC’s own consumer guide to buying a franchise.

The same report found that FTC received only around 5,900 franchise-related complaints between 2018 and 2022– under 1% of all complaints the agency received– despite franchise owners in every discussion group describing real concerns about their franchisors. Fear of retaliation and fear of violating contract terms were flagged as common reasons for why franchisees stayed quiet.

The report recommended the FTC do more to educate prospective franchisees and make its complaint process better known, and the FTC has since implemented all three recommendations.

Read more in Federal Trade Commission: Actions Needed to Improve Education Efforts and Awareness of Complaint Process for Franchise Owners (GAO-23-105338).

The FTC Has Been Sharpening Its Focus on Franchisor Conduct

In July 2024, the FTC announced a cluster of actions aimed squarely at franchisor practices. It issued a policy statement making clear that contract provisions barring franchisees from communicating with government regulators about potential law violations, including non-disparagement, goodwill, and confidentiality clauses, are unlawful, and that threatening franchisees with retaliation for reporting misconduct is likewise illegal. On the same day, FTC staff issued separate guidance stating that it is illegal for franchisors to impose fees on franchisees, such as payment-processing, technology, training, or marketing charges, that were not disclosed in the FDD.

Those actions followed a 2023 request for public comment that drew more than 2,000 public responses. The FTC Staff Issue Spotlight lists the dozen most common franchisee complaints, which range from unilateral changes to operating manuals and undisclosed junk fees to vendor kickbacks, retaliation fears, non-competes, renewal disputes, take-it-or-leave-it contracts, private equity takeovers, and liquidated damages clauses that can trap a struggling franchisee in a money-losing store.

The same Issue Spotlight reports that FTC staff reviewed more than 66,000 SBA-backed franchise loans from 2013 to 2023 and found franchise borrowers defaulted at a slightly higher overall rate (3.9%) than other small business borrowers (3.5%), with wide variation among specific franchise brands and lenders– reinforcing that franchise is not a single risk category, but a label covering systems with very different track records. For more on what these actions signal for the industry, see this Morgan Lewis analysis of the FTC’s expanded focus on franchise regulation.

None of this means franchising is a bad model or that every franchisor is cutting corners. It means the industry operates within a real, evolving regulatory framework, one built on the idea that if you have complete, accurate, and timely information, you can make your own informed decision.

A Franchise Is Not a Shortcut to Business Success

Investing in a franchise is simply another way to buy a business. Before you invest, do your due diligence. Look beyond the brand name and ask the harder questions. We lay out the broader legal, financial, and operational due diligence playbook in How to Conduct Due Diligence Before Buying a Business, much of which applies directly to franchise purchases as well.

The strongest franchise systems are most likely not the ones selling the most franchises. They’re the ones creating the most successful franchisees.

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