Franchise Disclosure Document: Most Important Sections
When you’re deciding on a franchise to partner up with in your next (or first) business venture, you’ll obviously want to do your research. For most, this is a no brainer, but one thing that might not be is the FDD or Franchise Disclosure Document.
Okay, what is the FDD?
Basically, the FTC, or Federal Trade Commission, needed to regulate the franchise space because franchisees were being kept in the dark about key company information. Essentially, they didn’t know who they were getting into bed with, and that was creating a multitude of less-than-ideal partnerships.
The FDD consists of 23 items that franchisors must provide to prospective franchisees before anything can be signed or a partnership can be formed. All of these items are critical information that needs to be reviewed properly before any life-changing decisions are made.
In this article, we’ll just be covering the top 8 or so items of the franchise disclosure document that deserve the most attention, to give you a starting point in your research and help you look out for those red flags.
FDD Item 1: The Franchisor And Any Parents, Predecessors And Affiliates
This section is fairly self-explanatory, but definitely worth talking out anyway. You can treat this item as a concise, yet meaningful, introduction to the franchisor and any relevant business units or former brand names the company operated under.
Comb through this very carefully and search for any suspicious rebranding, success rates, or sketchy partnerships. You won’t get all the depth necessary in just this item of the franchise disclosure document, but it’ll inform secondary research with greater accuracy than if you tried to wing it yourself. Don’t underestimate this.
FDD Item 2: Business Experience
I cannot stress enough how important it is to vet the individuals in this part of the FDD. Item two does you a solid and provides substantial information regarding the experience of the franchisor’s leadership team. It’ll show you their:
- Former employment experience
- Education and educational institutions
- Relevant experience to the franchise industry
- And usually some fluff regarding projects
The value here is hard to articulate. When you know who you’re getting into business with, you suddenly know who to go to for empowerment, answers, results, and other problems that might not be easily solved (and there will be plenty of those). So, due diligence here will assist in identifying weak links or especially strong ones. Do not ignore it, do not do it halfway, take your time.
FDD Item 3: Litigation
This one might be pretty self-explanatory, too, but just in case we’ll cover it a bit. This item of the FDD covers all current litigation the company is currently facing. If your franchisor of interest is rather large, you can expect the sum total of litigious events to be fairly high. That just comes with the territory.
If your franchisor is small, you’d want to be wary of excessive litigation volume.
In all cases, make sure to review the types of lawsuits coming in and adjust expectations accordingly. For example, if your potential franchisor is being sued for trademark infringement, this could be a red flag, but also, it could be a reality check to review your franchise agreement for trademark litigation support. You don’t want to be paying for those court expenses on your own.
Above all, legal matters tend to be some of the most important, so analyze and ask questions.
FDD Item 7: Estimated Initial Investment
So, you’ve heard about franchise fees. That’s good, you’re aware of what it costs to partner with your franchisor. Now it’s time to review how much it’ll actually cost you.
This number will vary wildly from franchise to franchise and industry to industry. The important thing to remember is that this is going to be your business venture. It’s easy to get caught up in the camaraderie of a franchise agreement and mistake support for operational responsibility.
This item of the franchise disclosure document will present you with itemization of the costs associated with opening the franchise and running it for the early days. Review it closely as this is where the bulk of costs usually lie. From real-estate, to equipment, staff, fees, etc. you’ll be able to get a ballpark figure for the things that actually go into opening the business. Get granular and don’t come up until you’re certain you can afford it.
FDD Item 12: Territory
Territory can be an easy to overlook FDD item because we often just assume we’ll be the only franchise in an area. This could be a financially fatal mistake.
Franchisors are there to make money, they don’t mind if you profit in the process, but at the end of the day, they go where the dollar signs are, whether you’re there or not. So, in the document, make sure your territory of operation is clearly outlined and that no competition is being fostered between franchisees of the same franchisor.
If there’s any language of territory being tied to performance, have a discussion with your lawyer and make sure you do all you can to remove this kind of inconsistency. In any business venture, you want to reduce the number of forces working against you, even if it’s coming from your franchisor.
FDD Item 19 Financial Performance Representations
We like to point out this FDD item as a sort of warning rather than a truly important section. See, first time franchisees often get caught up in dreaming about the amount of income to be generated by a franchise partnership. They get starry-eyed and rely on a sort of confirmation bias that gets presented here.
Item 19 will show you things you want to see. Information on profitability based on case studies and existing units will be at your disposal, and for some this can be an expectation of success. However, the data is usually incomplete or representative of a smaller subset of successful units.
The best and really only way to get information on profitability is to reach out to fellow franchisees with similar market conditions and ask them directly. Build a database of your own to confirm the information in this section. You’ll be glad you did.
FDD Item 20: Outlets and Franchisee Information
Here, you’ll find a compilation of various tables and data points that are absolutely useful across the board. It’d be difficult to cover everything in detail for the purpose of this article, and trust us, it’ll seem a tad overwhelming to comb through, but it’s well worth it to do so.
Get your hands dirty and granular again, get answers.
FDD Item 21: Financial Statements
This franchise disclosure document item is exactly what it says it is. Here, you’ll find an overview of the company’s financial situation over the last few years and the corresponding balance sheets for your review.
This information paints a picture of the franchisor’s stability and is one of the most invaluable factors connected to your overall experience as a franchisee.
For example, you’ll want to make sure that the franchisor has the budget and cash reserves necessary to provide essential support services to all of its units. You don’t want to run a partnership all by your lonesome at this level, trust us. It’s kind of like working with that one kid in school on a group project that didn’t understand what “group” meant.
FranchiseHelp is, well, here to help
Franchise disclosure documents are daunting to say the least, and they can be a bit discouraging in places, but don’t lose your way. Just because one franchise isn’t a good fit doesn’t mean that there isn’t a fit out there.
The last piece of advice we’d like to reiterate is that you need to do your homework. This isn’t a get rich quick scheme, no matter how you look at it. Time, effort, and asking lots of questions is the path to success.
Want help with your franchise homework? Take our franchise match quiz today to get a better idea of where to start!
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