Navigating the FDD
All franchisors are required by federal law to prepare a Franchise Disclosure Document (FDD), and furnish it to all prospective franchisees. See below for an outline of the contents or go here for a brief description.
This Section Explains the Items in the Franchise Disclosure Document
Item 1: The franchisor, its predecessor and affiliate: an overall description of the company, what they provide to the consumer, their historical background, location and any predecessor information.
Item 2: Business experience: biographical and professional information of any of members of the organization holding down important roles in the operations, or in support of the services provided to the business.
Item 3: Litigation. provides relevant current and past criminal, civil or administrative litigation of the franchisors and any of the office-bearers, owners, directors or key executives of the company
Item 4: Bankruptcy: provides information about the franchisor and any of its directors or officers who have gone through a bankruptcy within the last 15 years.
Item 5: Initial franchise fee: states the franchise fee amount and any other initial payments to be made by the prospective franchisee to the franchisor upon the execution of the franchise agreement.
Item 6: Other fees: provides a description of all other recurring fees or payments that must be made, such as royalties, advertising fees, insurance expenses, training costs, audit and accounting costs, consulting expenses, leases, alteration costs and any other fees which are associated with the franchise.
Item 7: Initial investment: This item includes all the expenditures required by the franchisee to make, to establish the franchise. The estimated expenditures associated with the opening of a franchise are calculated with an upper and lower range given for costs to be associated with real estate, construction, equipment, fixtures, permits, furnishings, signage, inventory, working capital, etc.
Item 8: Restriction on sources of products and services: this includes the restrictions that the franchisor has established regarding the source of products or services. If any goods, services, supplies, equipments or insurance are required to be purchased from a designated source, it must be disclosed here.
Item 9: Franchisee’s obligations: a disclosure of all the “principal obligations of the franchisee under the franchise and other agreements after the deal has been signed. This provides the prospect with detailed instructions about where to find every obligation in the legal agreement with the franchisor.
Item 10: Financing Available: describes the terms and conditions of any financing arrangements offered by the franchisor.
Item 11: Franchisor’s Obligations: a list of the systems the franchisor brings to the table to assist the franchisee in becoming successful. This item is intended to provide the franchise prospect with a clear understanding of how the business relationship with the franchisor is structured.
Item 12: Territory: provides the description of any exclusive territory rights and whether territories will be modified. Any conditions which the franchisee must meet to retain these rights, such as certain sales levels, must be disclosed here.
Item 13: Trademarks: provides information detailing the registration of trademarks, service marks, trade names, logo types and commercial symbols with the U.S. Patent and Trademark Office. Also to be included are the list of states and countries in which the marks are registered, as well as any limitations imposed on the franchisee for the use of these marks.
Item 14: Patents, copyrights and proprietary information: This lists any patents and copyrights that may be involved in the operation of the franchise and that may cover trade secrets and confidential information.
Item 15: Obligations to participate in the actual operation of the franchise business: describes the obligation of the franchisee as to whether they will participate in the actual operation of the business or simply act under a management role.
Item 16: Restrictions on what the franchisee may sell: deals with any restrictions on the goods and services that the franchisee may offer its customers. Any limitations or exclusions on goods and services that can be commercialized by the franchisee are clearly stated here.
Item 17: Renewal, termination, transfers and dispute resolution: tells you when and whether your franchise can be renewed or terminated and what your rights and restrictions are when you have disagreements with your franchisor. This is possibly the longest and most complex item in the entire FDD
Item 18: Public Figures: If the franchisor has any brand representatives or compensation or endorsement program with a public figure, it must be disclosed in this item.
Item 19: Earnings claims: provides details on earnings, costs, and other factors likely to affect future financial performance after a candidate signs on to become a franchisee. This is not required and some franchisors refrain from providing this information, concerned about the legal liability of making such claims. Read more here.
Item 20: List of franchise outlets: a summary of franchises sold, the number of agreements signed so far but not in operation, the number of franchises currently operating, and the number of company owned units. Information on the number of franchises terminated or not renewed with the actual causes for termination or non-renewal for the past 3 years are also required to be mentioned in this item.
Item 21: Financial statements: Audited financial statements for the past three years are included in this section.
Item 22: Contracts: This item provides all of the agreements that the franchisee will be required to sign.
Item 23: Receipt. Prospective franchisees are required to sign a receipt that they received the FDD.
What are the key items in the FDD?
Special attention should be given to the following items:
Item 7: Initial investment.
Some of these costs are averages or estimates and may vary in your area.
Talk to other franchisees that have been in the system for a year or more to see:
- how much money they needed in the beginning until they became profitable
- how long before they became cash flow positive to be able to draw from the business to support themselves
Item 11: Franchisor’s obligations.
Be sure you understand the services you will get before you open:
- site selection
- development assistance
Be sure you know what services you will receive for your grand opening:
- field support
Be sure you know what services you will receive after you begin operating your business:
Pay particular attention to those services the franchisor is obligated to provide and the services they may provide.
Item 17: Renewal, termination, transfers and dispute resolution.
Take your time to understand what rights you will have and what rights you are giving up.
Make sure that you understand the requirements and fees for transferring your franchise.
Pay particular attention to any non-compete provisions and your obligations when the franchise relationship ends.
Item 19: Earnings Claims.
Only 20 to 25 percent of all franchisors provide prospective franchisees with information about earnings claims. This is because the earnings are so dependent on so many factors: skillset and dedication of the franchisee, location of the franchise, marketing success etc
The next best thing to do is to talk to existing franchisees about earnings potential.
Item 20: List of franchise outlets.
Note the contact information of the franchisees that have left the system. These are people you will definitely want to talk to.
- Examine how many units the franchisor has taken back and resold. If this number is high, this could indicate churning (when the franchisor takes back failed locations and remarkets them over and over.)
- Be realistic! Some of these people may have failed and it was through no fault of the franchisor or the system.
Item 21: Financial statements.
Financial statements are the track record of the franchisor. You should be given copies of the franchisor’s last two or three year’s financial statements. Take them to an accountant who specializes in
franchising to evaluate.
Remember that the financial condition of the franchisor not only affects its ability to run a financially successful operation in the future, but it also determines whether it may go under and you will
be left “holding the bag.”
The two key financial statements to focus on are the balance sheet and the income statement.
- Make sure they are audited.
Item 22: Contracts.
- Make sure that all the agreements listed are attached to the FDD—and read every one of them and have them reviewed by a franchise attorney before buying.