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.
