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The Franchise Disclosure Document Tells a Story

by Ed Teixeira

When the Franchise Disclosure Document and franchise contract is properly reviewed it can tell a story about the franchisor. Learn which items are most important; what to look for and why you need qualified advisors.

The FTC requires that a Franchise Disclosure Document (“FDD”) be provided to prospective franchisees by franchisors. There are various sections to the FDD which can range from 100 to over 200 pages. These sections include the franchise contract, financial statements, list of current and terminated franchisees and several other exhibits.

There are 23 items in the FDD, which are in the form of responses required by the FTC to be completed by the franchisor. Information in the FDD pertains to the franchisor, franchise program, the franchise investment and the franchise contract. Each item in the FDD is important and should be reviewed by a competent person or professional. However, if certain items are reviewed by the right people they will tell a story about the franchise and it won’t be a mystery novel. You’ll find some highlighted text, which if clicked will lead to a more detailed explanation of that section.

Here are the Items:

Item 2 presents the business experience for the last five years of franchisor staff including directors and principal officers of the franchisor and most importantly franchise experience. Look for experience in the business sector that the franchise operates in.
Item 3 will disclose franchise litigation. This section can provide insight into who filed the original complaint. A franchise attorney can take a further look into the complaint to obtain more facts. You can relate the number of lawsuits to the size and age of the franchisor. Little or no litigation can indicate good relations between the franchisor and franchisees.
Item 7 presents the franchisee's estimated initial investment needed to begin operating the franchised business, including rent, inventory and equipment. It also shows the estimated additional capital for a 3 month period. The information from this section will help you construct your ROI and break even projections. Use this information when you speak with franchisees.

Item 11 will recite what the franchisor is obligated to do for its’ franchisees. The obligations can include pre-opening and post-opening assistance. This is where the “Rubber meets the road” regarding how much support the franchisor will provide. Is the franchisor providing minimal assistance to its franchisees? Use this information to find out from current franchisees just how helpful the franchisor is.
Item 12 provides information regarding the territory and whether or not that territory is exclusive. It will outline the franchisors and the franchisee's respective rights and restrictions in connection with doing business within the franchisee's territory. Is your territory really exclusive? Could there be potential franchise encroachment issues?
Item 17 depicts common provisions of the franchise agreement in a table relating to the franchisor-franchisee relationship and the specific items in the franchise contract.
Item 19 is an optional presentation of the historic or projected financial performance of the franchisor. If this area is blank ask the franchisor why. This section is used by approximately 30% of franchisors to disclose franchisee and company unit financial data.
Item 20 shows the number of franchised units and company-owned units in existence for the last three years and most importantly how many were terminated and why. You’ll be able to identify trends regarding franchise and company unit growth.
Item 21 contains the franchisor's financial statements: its balance sheet, income statement and cash flow statement. This information should be read by your accountant or financial advisor in order to answer a number of questions regarding the financial health of the franchisor.
Item 22 All of the proposed agreements relating to the sale of a franchise. Be sure you understand and recognize what documents you’ll be required to execute if you purchase the franchise.

Reviewing the FDD is an important part of the franchising process. However, there are particular sections of the FDD which can reveal a good deal about the franchisor and the franchise opportunity itself. Be sure these sections receive the right focus and use qualified professionals to assist in the process.