Reviewing the Franchise Disclosure Document (FDD)
Many people take a cursory review of the Franchise Disclosure Document to assess the business opportunity including sales, income and other factors that contribute to the success of the business model.
If you continue to believe this business model is a good fit for you, then you will want to take a deeper dive in the FDD either on your own or with the assistance of a franchise attorney to review both the FDD and the Franchise Agreement. It is imperative that any attorney considered is someone familiar with franchising & franchise law. For now, I recommend reviewing the FDD in the following manner, however I have highlighted suggested focus areas.
There are 23 sections in the FDD. Let’s review of some of the most crucial parts.
There will be information on the senior managers of the company. That is something you would want to know. Has there been an ownership change? If so, do the new owners have a background in the industry? Have the owners ever filed bankruptcy? This is the kind of information that will be included on the ownership, in Items #1, #2, and #4.
Has this company ever had a major law suit? If so, it will be detailed in the FDD. We all know even the most ethical company can be taken to court in The United States these days. So a single lawsuit might not be a reason to worry. But some franchise companies have literally dozens of suits between them and the individual franchisees. If you see that kind of litigation history you know you could be in for big trouble after joining that franchise. That’s a reason to pay attention to Item #3 – Litigation.
You know you have to make an investment in order to start a franchise, but how much? That’s also in the FDD. The company will give you ranges for every start-up cost that franchisees typically experience: rent and advertising and construction. They’ll tell you how much cash you should have on hand in order to cover your costs after you open. Look at Items #5, #6, and #7 for this information.
Most people know that a McDonald’s franchisee must purchase all of their food products directly from the franchisor. Does your franchise have a rule like this? You can find out in Items 8 and 16.
Some franchisors assign a protected territory, while others do not. Neither of these is necessarily “better”, but you’ll want to read Item 12 to understand how the territory works in the franchise you are considering.
Item 19 is the one that is most often talked about. This is the only optional part of the FDD. In this section, the franchisor is permitted to share the financial results from their existing franchisees. This is obviously important information to have. Unfortunately, only about one-third of franchisors provide this. But don’t worry – if yours does not, there is still a way to get this information.
The last item is usually cited as the most valuable. In Item 20 the franchisor is required to provide a list of their franchises as well as how many have opened and closed for the past two years. In addition, they provide phone numbers for all franchisees. This is important because they will be your best source of information on the business. You can call as many of the existing franchisees as you like. They will be forthcoming in answering your questions and helping you as they were in your shoes at one time.
Yes, the FDD is a long read. There’s a lot of information including charts, data, enough to make your eyes glaze over. But you will be well served to read the document. It is the key to learning just how good of an opportunity the franchise will be for you.
Thank You
Beth Gunier