While a franchise disclosure document (FDD) appears daunting to the potential franchisee, taking the time to thoroughly review the document in its entirety can help answer many questions and provide a transparent overview of a franchise opportunity.
To make it a little less stressful for any potential franchisee, here are some of the most important elements to make sure you cover – whether on your own or with an attorney:
What is a Franchise Disclosure Document?
A franchise disclosure document is a legal disclosure that is required by the Federal Trade Commission (FTC) to be given to franchise candidates. The FDD is broken down into 23 sections and contains vital information that allows potential franchisees to make an informed decision about the investment they’re about to make. This includes information on anything from litigation to initial fees, financing and franchisor assistance.
The FDD is a crucial tool for understanding a franchise opportunity – and can save a franchise candidate from any potential pitfalls of joining the wrong franchise, from misaligned expectations to litigation issues. Depending on your financial and business insight, it’s smart to have an attorney sit down with you and review it – two sets of eyes are better than one.
What Elements of an FDD Need Close Inspection?
The FDD is a hefty piece of reading that can be 100 pages or more, so it is critical to know what items need your close inspection can save you from tired eyes and missing key components of information.
Here are some of the most important sections to carefully examine:
Item 3 – Litigation: Item three covers all present and past civil and criminal litigation (for the last ten years), if any exists. If the Item 3 section is pages long, that should be a red flag and have you questioning a potential partnership with the franchisor.
Items 5 and 6 – Initial and Other Fees: These two sections cover the franchise fees, initial start-up costs, ongoing operating costs and marketing fees. Carefully scrutinize all of the fees so you can have a solid idea of the initial costs, helping you stay within your budget. This information will also assist you in determining your financing needs and options for your investment.
Item 7 – Estimated Initial Investment: Similar to Items 5 and 6, this section covers the expenditures required of the franchisee so they can get their franchise location up and running for the first three months. Initial franchisee expenditures include leasehold improvements, furniture, fixtures and construction fees and grand opening expenses. Item 7 can help answer questions, such as:
- How much is this franchise going to cost me?
- Who do I pay my investment to?
- Where do I spend that money?
Item 9 – Franchisee’s Obligations: This section covers what is required of the franchisee as a representative of the brand. While to some extent the franchisee is given autonomy, they are still obligated by the franchise agreement to abide by some rules and procedures that are essential for maintaining the brand.
Item 18 – Public Figures: This informs the franchise candidate of who, if any, the public figures are and how much that person is paid. A question you may want to ask yourself when you reach Item 18 is: Am I comfortable with the brand using this person for their brand awareness?
Item 19 – Financial Performance Representation: The Item 19 supplies franchise candidates with information regarding the revenue or profitability of franchised locations or company-owned outlets. It answers the question, “How much money can I make in this business?”
Item 20 – Outlets and Franchise Information: This section lets franchise candidates know how healthy the franchise system is as a whole and at the state level. The information in Item 20 is displayed in five straight-forward, easy-to-understand tables that show:
- An overview of system-wide locations
- The number of franchised locations transferred to new owners in each state where the brand has a presence
- A summary of the status of franchised locations by state
- A summary of the status of company-owned locations by state
- The projected growth by state for the upcoming year
- Along with the number of locations in the franchise system, franchisors must include the name of each franchisee and their address and phone number of each owned location. Franchisors are also required to provide names and contact information for franchise owners who left the system in the last year or who stopped communicating with them 10 weeks or more before the issuance of the FDD. This is necessary for franchisee candidates to conduct due diligence before signing a franchise agreement.
Item 21 – Financial Statements: This section provides any potential franchisee with insight into the financial health of the organization. If the company is not financially sound, that should raise a red flag.
Carefully reading the FDD is a critical step in any prospective franchisee's due diligence process – and in the right situation, should solidify your decision to align yourself with a franchise brand.
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