Posted on Apr 20, 2011
When Buying into a Franchise Opportunity, Go Beyond the FDD
Reviewing the Franchise Disclosure Document is an essential step for anyone considering investing in a franchise opportunity. And, as I have said before (Franchise Buyers Don’t Need a Lawyer –Yeah Right!), retaining experienced franchise counsel is a must. But, does your investigation and due diligence end there? Absolutely not!
The Franchise Disclosure Document (“FDD”) does not tell the whole story. Why?
First, the FDD regulations restrain franchisors from providing as much information as they may like ... and you may want. Restrictions imposed by state and federal law, intended to protect franchise buyers, may actually curtail information that may benefit purchasers.
Second, the FDD regulations offer franchisors options for compliance (in a few instances) that may reduce the amount or type of information provided.
To press beyond the limitations of the FDD, here are a few areas you should ask more about before you make the final decision to purchase:
- Business Experience of Individuals: The FDD regulations limit the Item 2 (Business Experience) disclosures for directors, officers and other individuals to the past five years of employment history only. And, many state franchise examiners are sticklers for insisting that any extra “fluff” be removed when this limit is exceeded (I believe the reasoning was to remove misleading puffery). But, if you were interviewing someone for a job, wouldn’t you want to know more? Of course you would. There is nothing prohibiting you from asking for more information about the people who will be calling the shots – especially during a personal, face-to-face meeting or telephone conference. Ask for more background.
- The Operations Manual: Occasionally referred to as the “hidden franchise agreement” and arguably one of the most important documents you should review before making a decision, when it comes to the Operations Manual, FDD Item 11 (Franchisor’s Assistance, Advertising, Computer Systems, and Training) gives franchisors an option. They can either superficially disclose the manual’s table of contents or offer buyers the chance to review the manual before purchasing. Most franchisors (maybe 99%) choose to disclose the table of contents only. I cannot fully explain why but it may be to guard against disclosure of “trade secrets” to knock-off artists or would-be-competitors shilling as buyers. Nevertheless, as a legitimate buyer you should ask to review the Operations Manual before buying – it will give you a true sense of the educational/operational value the franchisor brings to the table and a preview of day-to-day operations. If the franchisor resists the request, offer to sign a non-disclosure agreement; if that does not work, be wary. Review the manual.
- SBA Loan Performance: Yes, Item 20 (Outlets and Franchisee Information) requires franchise systems to list a three-year running statistical total of transfers, terminations, non-renewals, and so on, along with the contact information for each franchisee which has ended its relationship with the franchisor in the last fiscal year …but is this really that meaningful? A number of franchise systems register to participate in the U.S. Small Business Administration’s loan guarantee program known as The Franchise Registry. The primary purpose of the Registry is to pre-qualify franchise systems for the program to ease the SBA loan approval process for potential franchisees. A by-product is a report that the SBA issues each year entitled: SBA Loan Performance by Franchise Code – Data As of [a specific year-end]. This performance report shows the failure rate by franchise system for repayment of SBA-guaranteed loans. Trust me, it is an eye-opener. So, determine if the franchisor is part of the SBA Franchise Registry (you will want to know this anyway if you plan to pursue financing) and ask them to tell you what their failure rate is. If they can’t or won’t tell you, contact the SBA and get a copy of the report. If the system is on the Franchise Registry you will definitely want to review this.
That’s all the time (your time) we have for now … but stay tuned for more tips that you will not find in the FDD - Coming soon!
Jim Meaney is a lawyer with Zaino & Humphrey, LPA in Columbus, Ohio who has represented franchisors and franchisees for nearly 30 years. Jim is the co-author of “Starting a Franchise System: Practical Considerations, Planning and Development,” American Bar Association Forum on Franchising, 2010 Annual Forum (October 2010). He is also the author of How to Buy a Franchise. Visit www.fddlawyer.com or www.ohiofranchiselawyer.com for more information or contact Jim directly at 614.975.9876 or email@example.com.
NEXT POST: Franchise Fridays for April ...