Item 20: How to Evaluate Franchise Closure Rates

ITEM 20 IS THE SYSTEM'S VITAL SIGNS

If Item 19 tells you what you might earn, Item 20 tells you whether the business model is actually working — at scale, across hundreds or thousands of franchisees, over multiple years. It contains four tables: transfers, openings, terminations and non-renewals, and projected new openings. Read these tables together, not in isolation.

THE FOUR TABLES AND WHAT EACH MEANS: Table 1 shows transfers — existing franchisee-to-franchisee sales of operating units. A high transfer rate can mean franchisees are profitable enough to attract buyers; it can also mean franchisees are desperate to exit. Context matters. Table 2 shows new openings by state for the last three fiscal years. Table 3 is the most important: it breaks out closures by cause — terminations (franchisor-initiated), non-renewals (franchisee chose not to renew), reacquired by franchisor, ceased operations, and other. Table 4 shows projected new openings for the next year — a franchisor forecast, not a guarantee.

HOW TO CALCULATE NET UNIT GROWTH: The single most important number you can derive from Item 20 is the net unit change over the last three years. Take total new openings minus total permanent closures (terminations + non-renewals + ceased operations) for each year. If a system opened 60 units and closed 55 in the same year, it is essentially flat — despite claims about aggressive growth. Systems with consistently negative net unit growth are shrinking. A shrinking system means declining royalty revenue for the franchisor, which means less money for support, marketing, and R&D.

WHAT HIGH TERMINATION RATES ACTUALLY MEAN: Franchisor-initiated terminations may indicate: the franchisor aggressively enforces standards (not inherently bad), franchisee economics are so poor that many cannot survive (very bad), the franchisor is using terminations to reacquire units for resale, or the franchise agreement's default provisions are so broad that termination is easy even for technical violations. Interview former franchisees who were terminated — their perspective is more informative than the official record.

NON-RENEWALS ARE AN UNDERRATED SIGNAL: When a franchisee whose agreement expires chooses not to renew — even when they could — it means they evaluated the economics and decided the business was not worth continuing. Non-renewals are voluntary exits by people who know the system from the inside better than any prospective buyer. A high non-renewal rate is one of the clearest signals that franchisee profitability may be insufficient to justify another 10-year term.

COMPARE ACROSS YEARS — TRENDS MATTER MORE THAN SNAPSHOTS: Item 20 covers three fiscal years. Look at whether the trend is improving or deteriorating. A system with 10 terminations three years ago, 15 two years ago, and 22 last year is on a worsening trajectory. Single-year snapshots can be misleading; the direction of change matters.

THE FRANCHISEE CONTACT LIST — YOUR MOST VALUABLE ASSET: At the end of Item 20, every current franchisee (name, address, phone number) and every franchisee who left the system in the last three years must be listed. Call at least 10 current franchisees — picked randomly, not selected by the franchisor — and at least 5 former franchisees. Former franchisees, particularly those who were terminated or chose not to renew, will often be candid about what went wrong. Ask them directly: "Would you do it again? What would you tell someone considering buying into this system today?"