The Franchise Disclosure Document

A thorough review of the Franchise Disclosure Document (FDD) is a crucial step in the due diligence process when evaluating a franchisor. A typical FDD can be hundreds of pages long. While this may seem daunting, be sure to read the entire document. Maybe even consult a franchise lawyer, and make sure to have any questions you have answered by the franchisor.

The Federal Trade Commission mandates franchises provide this standardized document to candidates, each containing the same 23 items. This allows you, the franchise candidate, to effectively compare offerings between franchises. Updated annually, the FDD provides a wealth of information about the franchisor, painting a clear picture of what you can expect from your relationship with the franchisor and what it will expect from you.

Keep in mind, just because a FDD lists costs, fees and obligations for which a franchisee is responsible, the FDD is not one-sided. It may protect the franchisor, but it also protects franchisees. Think of it as sort of a home owner’s association, protecting your business long-term.

While all items contain vital information, here is a summary of points of interest to which you may want to pay particularly close attention:

A list of the existing franchisees

The most valuable source of information about any franchise system is existing franchisees. Use this list for validation purposes. Plan to call or visit franchisees and their stores. Get a sense of the prevailing attitude of the group. Are most of the franchisees positive and happy about the decision they made? When speaking to an unhappy franchisee, listen to their complaints, but also determine what makes this franchisee different from the rest and whether theirs is an isolated case.

Item 3: Litigation

Take note of any litigation and the type. A high frequency of litigation could be indicative of an unhealthy network. However, not all litigation is negative. Instances of litigation with the franchisor acting to protect the brand and network of existing franchisees can be seen as positive. This indicates the brand is strong and your investment will be well protected from any potential brand detractors.

Item 6: Fees

Consider if the various fees listed here are truly value-adds. Can you validate and verify franchisees receive direct support and services? Does the brand follow through and provide the support it claims? Do you see commitment to franchisee success? Validate the franchisor cares about you and is not just about collecting royalty checks.

Item 7: Estimated Initial Investment

Here you will see a detailed breakdown of costs, including working capital and investment ranges. It is important to note that some FDDs are intentionally broad about investment costs, often understating working capital to make the investment appear to be lower than it really is. Ideally, you should be able to narrow it down and get a reasonable idea of what you can expect.

Item 19: Financial Performance Representations

This particular item is optional to disclose, not all franchisors will include it. If it is excluded, you should ask yourself why. This is not just about average sales or other metrics, it also shows the timeframe that seems reasonable to reach stated averages. Are you comfortable with that timeframe? Do you see yourself capable of exceeding that average sooner? Why or why not? Determine if it will meet expectations in the short and long term.

Item 20: Outlets and Franchise Information

This will show overall trends in the franchise by giving the last three years' historical growth of the network, broken down by state. This information will give clues of the health of the brand. It will also substantiate the franchise’s continuity rate. Any business failures, ownership transfers, franchise agreement terminations or other potentially adverse information relating to the success rate of the existing units in the system are included. The personality of the franchisor can be seen here. Information in this item will show how the brand’s culture manifests itself in its relationship with franchisees. To read more about how Item 20 can be used to improve your validation insights, click here.

Audited Financial Statement

Explore the details of the audited financial statement for the franchisor. This can indicate the franchisor’s maturity in the market and intention. If the royalty revenue far exceeds franchisee fee revenue, the franchisor may be more established and no longer dependent on that revenue to survive. If so, it would be more likely to be more selective in awarding franchises, searching for highly qualified candidates that would be a great fit for a well-established system.

Investing in a franchise is a monumental decision, knowing what to look for in a brand’s FDD will help you make a more informed decision. The above is just a summary of some key points to examine in the FDD, but you should consider all the information it contains carefully.

When it comes down to it, you will need to look beyond potential returns and ensure the brand is in alignment with your goals and values. Verify the franchisor maintains an overall positive and productive relationship with franchisees. Is it fair and reasonable in its dealings? Does it live out its core values, and is strong culture maintained?

Above all, ask questions and make sure the answers you receive are ones you can live with, do business with, and grow with for years to come.