Franchise Disclosure Document for Dummies – Part 8
In the final segment of this series on understanding the Franchise Disclosure Document, we take a look at Items 20, 21 and 23. Item 20 discloses system size and growth data, Item 21 contains the franchisor’s financial statements, and Item 23 consists of the receipt pages for the FDD (Item 22, which identifies contracts the franchisee is required to sign, is reasonably self-explanatory).
Item 20 – Outlets and Franchisee Information
Item 20 consists primarily of 5 tables that provide information on the number of franchised and company-owned outlets operating under the franchisor’s brand and business system.
Item 20 Tables:
- System-wide Outlet Summary (summarizes openings and closings of franchised and company-owned outlets over the past 3 years)
- Transfers by Franchisees to New Owners
- State-by-State Summary of Opened and Closed Franchised Outlets
- State-by-State Summary of Company-Owned (non-franchised) Outlets
- Projected Openings for the Coming Year
Except for the projected openings table, all of the Item 20 tables must provide information for the most recent 3 years of the franchisor’s operations.
Item 20 must also include contact information for (i) all current franchisees, and (ii) all former franchisees who left the system during the past fiscal year. Franchisees may request for the franchisor to provide limited or alternate contact information (such as an email address instead of a phone number for home-based franchisees). For franchisors with significant numbers of franchisees, this disclosure will typically be made in a separate Exhibit to the FDD.
Depending on the status of the franchise system, Item 20 can be an important sales tool for franchisors. It can also be a significant resource for prospective franchisees, who will want to review geographic distribution and termination figures in particular, and use the contact information to obtain as much information as they can from both current and former franchisees.
Item 21 – Financial Statements
Franchisors must disclose their financial statements in Item 21 of the FDD. The disclosure requirements are uniform for established franchisors (audited balance sheet and income statement for the 3 previous fiscal years), but there is a “phase-in” for new franchisors which allows them to provide limited financial disclosures during their initial years of franchising.
Importantly, where the franchisor also operates a unit-level business (i.e. a company-owned outlet), its financial statements may effectively constitute a Financial Performance Representation, potentially triggering mandatory disclosures and representations in Item 19 of the FDD. This is because, in such circumstances, the franchisor’s financial data provides an indication of the revenue and expenses of an operating outlet. In this situation, the franchisor must be careful to state that the information disclosed is not a representation of prospective franchisees’ likelihood of success.
In certain circumstances, franchisors may also be required to disclose the financial statements of their parents, affiliates and subfranchisors. If this is the case, in performing their due diligence prospective franchisees should carefully evaluate all of the financial information disclosed. A shaky affiliate who provides key support or branded products could be a bad omen.
Item 23 – Receipts
Finally, Item 23 of the FDD contains two copies of a standardized receipt for the FDD. Prospective franchisees must sign both copies—keeping one for their records and returning the other to the franchisor. The receipts will identify all Exhibits that should be included with the FDD, and they contain important information regarding the timing for signing the franchise agreement (the federal rule provides for a 14-day “cooling off” period, but some states have different requirements).
The receipt pages must also state the Issuance Date of the FDD, and prospective franchisees should make sure that the date listed here is consistent with the date listed on the cover page of the FDD.
Franchisees should read the receipt pages carefully, and thoroughly review the FDD to make sure that it contains all necessary information so that they can make an intelligent decision about their chosen franchise opportunity prior to signing on the dotted line.
Jeff Fabian is the owner of Fabian, LLC, a boutique intellectual property and business law firm serving new and established franchisors and prospective franchisees. Contact the firm directly at 410.908.0883 or jeff@fabianlegal.com. You can also follow Jeff on Twitter @jsfabian.
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This article is provided for informational purposes only, and does not constitute legal advice. Always consult an attorney before taking any action that may affect your legal rights or liabilities.
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Why I Have an Issue with the Forbes Franchise Rankings
The 5-Year Growth Rate and 5-Year Franchise Continuity are both great independent metrics of how a franchise is doing on average. As a potential franchisee both of these statistics are vital for selecting a franchise - you want to select a franchise that will provide you with a high return on investment and which will survive in the long run. I think these are, as FRANdata and Forbes suggested, two of the biggest (if not the two biggest) and most obvious metrics for whether or not a franchise is a “good” opportunity for a franchisee. But how do you use these to determine which franchise is BEST? This is the fundamental difficulty in coming up with a ranking system - it isn’t the difficulty in separating the good from the meh from the bad - it’s separating the great from the good and the best from the great. In the case of these rankings I found it to be pretty difficult to comprehend how they differentiated between the top ranked franchises. For instance, if you look at the difference between Discover Map (Forbes #4), Just Between Friends (Forbes #5), & Seniors Helping Seniors (Forbes #6) they all have extremely close continuity ratings and substantially different growth rates. In fact, in the case of these three, the overall rankings are opposite the growth rate rankings. Seniors Helping Seniors is ranked at the bottom of these three franchises despite having a growth rate that is 31 percentage points higher than Discovery Map and a continuity that is only 2 percentage points lower. This suggested to me that continuity was viewed as the dominant factor. But that logic didn’t hold for the rest on the “Economy Class” Top 10, as BrightStar Care (Forbes #7) had the same growth rate as Pop-a-Lock (Forbes #8) but a continuity rate that was 12 percentage points lower. These comparisons show that these were not the only two factors that went into the rankings, which is understandable, but no other factors that are explicitly listed in their results seem to be major factors.
