Franchise Disclosure Document (FDD) provides prospective franchisees like you the information you will need to make informed decisions. In the United States, Federal Trade Commission (FTC) requires every franchisor to disclose information about its past including any history of litigation or bankruptcy and franchisees who left the system. Also franchisors should disclose information about many other factors including costs, territory, the franchise program, and the franchise agreement you will have to sign. The FDD has to meet federal regulatory reporting standards in order to protect you from fraud. Misrepresenting material information in the FDD is a crime, so franchisors are very careful to be complete and truthful.
There are 23 items in FDD that disclose various information you need as a basis for further investigation and taking the final decision. Fortunately FDDs are uniformly organized to be the same in every state for every franchise opportunity. In this article we outline different items within a typical FDD and give you a general overview about them.
THE SUMMARY PAGE
This page tells you how much your total investment in the franchise should be and the services or products the franchise offers. A typical franchise fee for a unit franchise is between $35,000 and $50,000, but could be much more for some
high-value franchises or for some prime territories. The summary also includes and estimated range for start-up fees, which might include build-out and operating capital needed to start the operation.
Item 1 – THE FRANCHISOR AND ANY PARENTS, PREDECESSORS, AND AFFILIATES
This section of the FDD should tell you if the franchisor owners or executives are qualified by personal experience to teach, train and advise you on the business. Do the executives of the company actually operate the same kind of business or location they are franchising? Do any of them own franchised locations in the same company? Or is the franchise a new concept with short track record? Look to understand who the franchisor operators really are, as individuals. You also want to know specifically what key individuals would be responsible and available to help you if something goes wrong.
Item 2 – BUSINESS EXPERIENCE
This section will also tell you if the franchisor owners have an active location to test products, services and developments. It’s also an indicator of the commitment level those individuals, because if they own their own stores they probably believe strongly in value of the investment. How long have the executives been with the franchise? Are there corporate stores, or do the president and key members own stores as separate franchises? That could be a good sign.
Item 3 – LITIGATION
This section is an indicator of how the franchisor might handle conflicts. How many lawsuits, if any, have they had? They should not have had many. Is there a paAern to the types of lawsuits? Are there any open lawsuits? If so, this section can give you some idea of future financial pressure on the franchisor if they lose the litigation. Also look for any cases of fraud or felonies. You may want to conduct Internet research on the franchisor as well as key principals to determine if there any legal issues that might interfere with your potential for success.
Item 4 – BANKRUPTCY
A bankruptcy in the distant past is not necessarily a drawback if the company ended up coming out of it stronger with provisions for curing what caused the bankruptcy in the first place. If there was a bankruptcy in the past has the company reorganized and revitalized since? Has ownership and management changed since the bankruptcy? The financial reports will tell you the story.
Item 5 – INITIAL FEES
The franchise fee is supposed to cover the cost to get a franchisee signed and then trained. Franchise Fee is used to help cover training, legal fees, and other costs to adding a franchisee.
Item 6 – OTHER FEES
The other fees section outlines any other fees involved. You need to check if these other fees are reasonable compared to similar franchises. You need to consider these as you prepare your own business plan.
Item 7 – YOUR ESTIMATED INITIAL INVESTMENT
This section should include three months of estimated operating expenses as it often takes this long to start building your business and start making enough revenue to cover monthly overhead. Look at this chart carefully.
Item 8 – RESTRICTIONS ON SOURCES OF PRODUCTS AND SERVICES
Check to see if there are restrictions on sourcing. There may be a good reason for this if the franchisor has a proprietary formula or recipe, or special quality requirements, or if the franchisor has negotiated volume discounts that they pass on to the franchisees. Determine if what you must pay the franchisor for supplies or inventory is high for identical items you could buy for less somewhere else. Does the franchisor overcharge you for products you are required to purchase through them or their designated vendors? Are you allowed to purchase from outside vendors? You should consider if the franchisor getting rebates for making you use certain vendors. If so, are volume purchase savings being shared with franchisees?
Item 9 – FRANCHISEE’S OBLIGATIONS
This is a directory of where to find your various obligaSons throughout the FDD. You need to know these clearly before you accept a franchise award.
Item 10 – FINANCING
This section describes whether the franchisor offers financing and what kind. If you need financing you should take time to be sure you can qualify before you invest too much time.
Item 11 – FRANCHISOR’S ASSISTANCE, ADVERTISING, COMPUTER SYSTEMS, AND TRAINING
This is a very important part of the disclosure. These are the obligations the franchisor agrees to prior to your location opening. Look for a well-developed training program. There is a training chart that shows the training program and type of training you will receive. More support is always better.
Item 12 – TERRITORY
What is the protection for the territory you are buying? The territory should be clearly mapped, defined and agreed upon before you sign the franchise agreement. You want a protected territory for most retail and service franchises because it is common that as the brand gets larger, a franchisor may allow for more units in each territory. You want to make sure the territory is not over-saturated.
Item 13 – TRADEMARKS
Check to see if the company has any registered trademarks. A good resource for information and checking the trademark is www.uspto.gov. Who actually owns the trademark? If the franchisor has a license for the trademark owned by someone else, will you be able to use it if the franchisor’s license is terminated? Look at this carefully. You must have federal protections of the trademark to ensure brand value.
Item 14 – PATENTS, COPYRIGHTS, AND PROPRIETARY INFORMATION
Are there patents? If so, how important are they for the success of the franchise? Are they critical? A patent only lasts for 17 years. Check to see how many years are led on the important patents. Consider the impact to your franchise when the patent expires.
Item 15 – OBLIGATION TO PARTICIPATE IN THE ACTUAL OPERATION OF THE FRANCHISE BUSINESS
This section is important if you would like to run your franchise as an absentee owner using hired management. The obligations about your degree of involvement in the day-to-day activities should be listed in this section.
Item 16 – RESTRICTIONS ON WHAT THE FRANCHISEE MAY SELL
Are there any restrictions on what you can sell at your franchise location? What restrictions will you have on advertising, soliciting and selling? Can you add products for retail sale or is it restricted to only what is offered by the franchisor? This is an important consideration which could impact your financial projections.
Item 17 – RENEWAL, TERMINATION, TRANSFER AND DISPUTE RESOLUTION
Renewals should be available so the franchise can operate for 20 years or more. Renewals in perpetuity are ideal. Check for renewal fees. Are they predictable and reasonable? The franchisor does not incur much expense when you renew, so the fees should be minimal.
Item 18 – PUBLIC FIGURES
This section lists any public figures involved in the promotion of the franchise. Are they owners, spokesmen, or actual franchisees? You will want to consider the length of contract and whether they are critical in having a successful business. What will be the impact if they stop promoSng the franchise? What happens if this high-profile person is involved in a scandal or lawsuit? What if their poliScal or religious views are controversial? Make sure you consider the ramifications of this agreement.
Item 19 – FINANCIAL PERFORMANCE REPRESENTATIONS
This section contains the past earnings of individual franchise locations. You and your accountant should study these carefully so you can judge:
- What can you reasonably expect to earn from operating the franchise, both in salary and in profit?
- Is it in line with your goals?
- Is it worth the investment?
Be sure to look at the footnotes. Some of the most enlightening information is there. Also look at the individual location information to see if any of the units are struggling or showing losses. A failing franchise locaSon might be the caused by
the franchisee, the franchisor, by some extraneous factor that has nothing to do with the actual business, or a combination of things. It’s not always easy to tell in an FDD, however, you can ask questions about this in validation interviews.
Item 20 – OUTLETS AND FRANCHISEE INFORMATION
This is the list with all of the franchise units. Look to see if the location you are seeking is still available and to assess the health of the franchise. How many new franchisees are they selling? How many franchisees have left the program? How or why did they leave? Are there terminations initiated by the franchisor?
Item 21 – FINANCIAL STATEMENTS
These are the franchisor’s financial statements. This secSon helps you estimate the solvency of this franchisor’s system. If you like the other aspects then have an accountant review these statements with you, especially if you’re not expert at financial statements.
Item 22 – CONTRACTS
This shows all of the contracts you will need to sign to acquire this franchise. If you are serious about pursuing the franchise, you will need to read these contracts yourself, and also have your franchise attorney advise you. If you intend to operate this business with your spouse or a partner, both of you need to do this.
Item 23 – RECEIPTS
The government requires a cooling off period of 14 calendar days after receiving the FDD before any transaction is allowed to take place. You must sign, date and return a receipt acknowledge for the FDD to the franchisor. Franchisors need this document from all candidates in order to stay compliant with Federal Trade Commission regulations. You should return the FDD receipt to the franchisor at least two weeks before the discovery day.
Please call us at (949) 228-6639 or simply fill out the form on this page to schedule you free consultation for buying a franchise.
Sources:
- Buying a Franchise: A Consumer Guide, Bureau of Consumer Protection Business Center
- How to Buy a Franchise, Legacy Franchise Group
