The Franchise Disclosure Document (FDD)

The Federal Trade Commission (FTC) requires all franchisors to provide prospective buyers with a Franchise Disclosure Document, or FDD. The FDDs are typically several hundred pages long and written and reviewed by a team of attorneys. To say an FDD can be overwhelming is an understatement.

The good thing is that every FDD is organized into a common format for easy comparison between franchises. Also helpful is that the FTC has regulations in place to protect the prospective franchisee. For instance, the FTC requires prospective franchisees to have the FDD for a minimum of two weeks before they can sign a franchise agreement, they limit the franchisor from making earnings claims outside of what is in the FDD, and they place several checks and balances within the Discovery Process to give a potential owner the chance to thoroughly validate the facts and figures they uncover.

In addition to the protection provided to a potential franchisee by the FTC, you have one added safeguard in this process…FranCoach! It is our role in the Discovery Process to help clients understand all the information they receive, ensure they are taking all the necessary steps, and asking all the right questions.

Though there are many other key facets of the Discovery Process, the FDD does play a prominent role in finding the right franchise. A common misconception however is that the FDD will provide all the answers needed to determine which is the best franchise. This could not be further from the truth.

Think of the FDD as a road map of sorts – helping guide us to our final destination. We want to use the information in the FDD to determine what questions to ask rather than taking information in the FDD as the final answers. These questions will typically be posed to multiple people within the franchise as well as the existing owners you will speak with. The answers received from these questions will ultimately help gain the level of clarity needed to know which is the best franchise for you.

The FDD has 23 sections (referred to “Items”); as well as exhibits that provide a ton of supplemental information.

Here is your guide to understanding the FDD:

Items 1-4: History

• Item 1: A general review of the company, including predecessors or affiliates, and the opportunity being offered.
• Item 2: Background data on key officers, directors, employees, and any others who have management responsibility related to the sale or operation of the franchise. It includes a summary of their work experience from the past five years and any other experience they have as officers and/or directors of other companies.
• Item 3: This includes disclosures of any past or current litigation or bankruptcy on the part of the company or its key people.

Items 5-7: Fees and Costs

• Item 5: All initial fees you must pay as you begin the franchise business.
• Item 6: All other fees that may be required in the subsequent operation of the franchised business including royalties, advertising, renewal and transfer fees.
• Item 7: An outline of every component of the initial investment you’ll be expected to make in the franchise operation, including an allowance for initial advertising and operating capital reserves. This section is extremely important, but the value of information is limited by the fact that the franchise is required to express data in a tabular form involving ranges of potential costs. Review this section with existing franchisees and the franchisors to determine the most accurate estimate possible for your specific location and circumstances. You will also be able to review this with FranCoach!

Items 9, 11, and 15: Contractual Obligations of Franchisee and Franchisor

• Item 9: Your obligation as a franchisee. This Item lists the major areas of responsibility in the business (for instance, what is your role in finding the real estate site for your business) and then provides specific references to the exact sections on both the FDD and the actual franchise agreement that defines the legal obligations you’re assuming.
• Item 11: The contractual support obligation of the franchise. This Item is very important because it tells you what you’ll receive in exchange for the fees you’re paying. This section outlines pre-opening as well as on-going assistance. It also provides extensive details about the franchisor’s training programs and any required franchise systems, such as computer, point of sale equipment, or advertising programs that the owners are required to utilize.
• Item 15: Explanation of exactly what your personal obligation is in relation to the operation of the franchise business.

Item 12: Territory

• Item 12: Explanations regarding the territory you will receive. How large is it, is it protected or exclusive, what are the options for larger or multi-unit territories? You’ll find quite a variance in the provisions from franchise to franchise and it will be important to understand what is being offered as well as the franchisors thought process behind it.

Item 19: Financial Performance Information

• Item 19: Franchisors representation about the financial performance of their existing owners. This is often the first Item prospective franchisees read to determine the answer to the most commonly asked question in the Discovery Process, “How much money can I make in this business?”

  Item 19 will never give you the complete answer to this question however. In fact, the disclaimers of every Item 19 representation make this point in the clearest and most empathic language possible. Every franchisee is different, every site is different, and it is simply impossible to predict in advance what future financial performance results you might achieve.

  What Item 19 does provide – and it is extremely valuable – are the pieces to the revenue puzzle. This section will help generate numerous key questions to ask the franchisor and the existing owners to paint an outstanding picture of the income potential.

  Item 19 can be one of the most important sources of information you’ll receive in the entire FDD. However, it is very important to remember the FDD does not provide the final ANSWERS but rather the information needed to generate the QUESTIONS to ask. The answers to the questions generated from the FDD will be a major piece in determining the best franchise for you.

Item 21 and 22: Financial Statements and Contracts

• Item 21: The franchisors audited financial statements for the previous three years. Examine the financial statement to determine the financial strength and stability of the franchise.

  Remember, use the information in all sections of the FDD to generate questions and not simply to form conclusions. A franchise might have an ugly bottom line over the last two years because they just invested several millions of dollars to create a new proprietary program to help their owners become more efficient and successful.

  • Item 21: All contracts you may be required to execute in conjunction with becoming a franchisee, including the actual Franchise Agreement as well as other contracts covering personal guarantees, real estate assignments, advertising, co-op rules and conditions, and territorial development schedules.

Other Rules, Restrictions, and Information

• Items 8, 10, 13, 14, 16, 18, and 23 all contain important information pertaining to the franchise. Some of these sections relate to rules, such as where you can buy your supplies, what products or services you can offer, and what your obligations are as far as personal participation. Others contain information about and financing programs available through the franchise, any public figures involved on promoting the business, and the status of all trademarks, patents and copyrights. In addition, there are standard exhibits in every FDD with required listings of state-specific information and other “housekeeping” matters.

And the rest…

• The back roughly 2/3 of the FDD will be a copy of the Franchise Agreement and any addendums that go with it. While this will be hugely important to read and understand, we usually recommend holding off taking a deep dive into the agreement until we have determined which franchise is the best match.
• Then, reviewing the agreement will be important. Rarely are things in the agreement altered but it is vital to understand what it says and means. If you wanted to utilize a franchise attorney, this would be the time to do so. And if you do want to have an attorney review the agreement it is imperative that you hire an attorney who specializes in franchising. Not doing so would be akin to hiring an accident attorney to represent you in a divorce.

Summary

Yeah that is a lot, we know. Remember the two biggest mistakes people make with the FDD.

One, they postpone the next conversations with the franchisor so they can read and understand every word of the FDD. The FDD will be a part of most every conversation you have throughout the rest of the Discovery Process so keep the ball rolling with the scheduled franchisor calls. Also, don’t forget that we will have regular calls scheduled throughout the Discovery Process and we will constantly be talking about the information in the FDD (and everything else for that matter).

Secondly, the FDD is where we come up with the next layers of questions to ask the franchisors and their owners. The FDD is not where we find the final answers, especially relative to all things financial. This is called a PROCESS for many reasons – the key is to continue taking the steps and asking the questions. The answers to these questions will lead us to the clarity needed to find your perfect franchise.

We hope this document will help you as you begin to tackle the FDDs you receive. We will go over your questions on our next call and of course always feel free to reach out anytime.