If you’re just starting out in the franchise industry, either as a prospective Franchise Owner or a business owner who is looking to start franchising your concept, chances are you’ve come in contact with a term you’re going to be hearing a LOT: Franchise Disclosure Document. As the legal backbone of a franchise organization, the Franchise Disclosure Document, or FDD, as it’s often called, is the single most important document a franchise candidate will receive. Let’s take a look at what goes into the FDD, and how to tell if the franchise company you’re looking into is a sound investment based on the quality of the information and detail in the document.
We’ll start by saying that our VP of Sales Brian Knuth summed it up perfectly in an interview with 1851 Franchise, saying, “To put it simply, an FDD is the legal documentation of the offering a franchise organization is selling to an awarded franchise buyer… It outlines the history of the business, fees, rules and restrictions, all the franchisees in a system, turnover rates, renewal terms and other aspects of a particular franchise.”
An FDD outlines everything you need to know about a franchise, with 23 separate sections dedicated to telling you every detail about the franchise, from any parent company that might actually own the franchise to pending or past litigation to financial statements; however, with many FDDs numbering somewhere north of 200 pages, the document can quickly become a tedious read if you are new to the world of franchising. We can not impart enough about the importance of reading the entire document (more on that in our next section).
An FDD is basically your introduction to the franchise, and you will need to read it carefully to understand what’s expected of both you and the parent company. Once you receive your FDD, it’s best to go over its contents with a franchise attorney (or an experienced Franchise Owner) to fully understand what you are agreeing to.
In the simplest terms, an FDD is a legal document that allows you to make an informed decision as a potential Franchise Owner. You legally are required to receive the document no less than 14 days after signing a franchise agreement or giving the franchise Founder or parent company any money to start your journey of becoming a Franchise Owner.
You need an FDD not only for the legal protection that comes with it but also to understand the company you are looking to join. While things like history may seem unnecessary for you to know about, it helps you understand the Founder’s vision for the company and the image they would like to project. Other things you will learn about include litigation taken against the company, bankruptcy history, initial and ongoing fees, your estimated investment costs, any restrictions on products, both your obligation to the company as well as theirs to you and a host of other information that allows you to learn exactly what you are going into when signing with a company.
Some people can easily become confused by an FDD which is why we recommend hiring an attorney with experience in franchising to examine the document with you. For example, many people will see the company’s financial disclosures and believe their franchise will bring in the same amount (or more). In actuality, an FDD cannot tell you how much you will earn; it can simply show you what similar locations make annually.
A successful franchise wants to openly share its success with you, not hide it from you or give it to you “off the books.” For example, shady franchise companies have been known to provide FDD Item 19 (Financial Performance Representation) in a separate document. This isn’t good news for you; instead, it shows the parent company might not abide by the rules—especially in the services they must provide you as the Franchise Owner. Instead, a successful company will fully disclose this information in the FDD, allowing everything to be on the books.
Item 20 of the FDD will show you statistics for other Franchise Owners, including turnover rates and the number of franchise agreements signed but not yet open. These two statistics are integral for you to take a good look at. Franchise Founders with a high amount of turnover may have a troubled system that does not provide adequate support to Franchise Owners or signs franchise agreements without looking at whether or not the business can be successful while a high amount of signed but not opened franchise agreements can mean the franchise does not offer adequate support in opening the business or adequately examining if Franchise Owners are able to open the business.
In Item 7, you will see estimated startup costs to become a Franchise Owner. A properly formatted document includes a detailed estimate laying out these costs so you can understand how much money you need and where it will be spent. Of course, these are just estimates (and some companies do not include a real estate estimate), with the franchise making their best guess. However, some companies will not disclose where this money is supposed to go or even the factors used to determine their estimate. If something is in doubt, contact the parent company for a detailed breakdown (which they need to be able to provide).
A legit FDD will provide a potential Franchise Owner with a list of names and contact information for every current Franchise Owner as well as those who have left the company in the last year. You should take the time to contact an assortment of current and ex Franchise Owners to gather their general thoughts about the company and confirm information (especially financial) in the FDD is accurate. Some former Franchise Owners will have personal issues with the franchise, so you should take that into consideration, however, talking to a few ex-Franchise Owners can allow you to spot patterns that have led numerous people to leave.
Becoming a Franchise Owner can be a rewarding experience, but it’s also important for you to complete your due diligence when making such a life-changing decision. One of the best ways you can avoid shady or corrupt franchises is to use a Raintree. Raintree is dedicated to bringing potential Franchise Owners and Founders together to create strong business relationships. For more information, please visit our website by clicking here.