Fairly early on in the franchise process, franchise hopefuls will receive a document known as the Franchise Disclosure Document (FDD). Franchise disclosure documents are legally mandated by the Federal Trade Commission. Buying a franchise and becoming a successful franchisee requires you to carefully read the FDD for your selected brand and clearly understand its terms before entering into a legal relationship.
Most individuals outside of the legal profession initially view the franchise disclosure document as an overly onerous legal document, as complex as it is confusing, and that’s mostly correct. But as you become acquainted with the document and shed your initial sense of overwhelm, you’ll realize that it’s relatively well structured. Even better, the language is written at a level that can be understood by the average person. You absolutely possess the ability to read and understand its contents.
When armed with the knowledge of an insider, you can successfully leverage the information in the franchise disclosure document to gain greater insights into the quality of the franchise brand you’re considering.
**Note that since the franchise disclosure document is a legal disclosure document and not a legally binding contract, you don’t necessarily need to hire a lawyer to review it. But before signing the legally binding franchise agreement, you should absolutely consult a franchise-specific attorney. The information in this article should not be used as a substitute for legal advice from a licensed attorney.
The franchise disclosure document is a document the Federal Trade Commission (FTC) mandates each franchisor to offer each of their respective franchise candidates. At a basic level, the intent of the FDD is to define the legal relationship between the franchisor and franchisees. At a deeper level, the FDD is written to protect the brand (and everyone who has invested in the brand), since a single franchise owner will be entrusted with enough responsibility to potentially harm the brand without the details of that legal relationship being firmly in place.
Here’s the underlying truth that no franchise development representative or brand is likely to tell you directly: since the franchisor is responsible for creating and establishing the terms of the franchise disclosure document, it’s underlying intent will always be to ensure that if a legal dispute arises between the franchisor and a franchisee, the franchisor is slated to win.
I’ve explained this to franchise candidates in the past (and just as directly). Their responses are almost always the same: “Who in their right mind would sign that?!” But it’s not at all unusual for the terms of an agreement to favor whoever wrote it. Have you ever gone over a rental or lease agreement with a lawyer? You’d be surprised by the terms that you’ve agreed to in the fine print of most of contracts you’ve signed.
The number of active franchises has grown significantly over recent years, and since the beginning of this year, my responded to balking candidates by reminding them: “There’s about 750,000 active franchise agreements as we speak.”
If the terms of the franchise disclosure document are so unfair, then why do people keep signing up? In truth, have the terms of the franchise relationship set by the franchisor is not necessarily as unfair as it may sound:
The franchisor is responsible for protecting the investments and greater good of the collective franchise system. For all other franchise owners to be able to survive, they must first ensure that no one franchise owner can bring down the entire brand.
But here’s the other truth: if a franchisor is only offering the support and functionality described in the legal doc, it puts the entire brand in jeopardy. For the franchisor to succeed, the vast majority of the franchise owners need to be succeeding, and in order for that to happen, they need to offer robust support functionality and constantly be working on behalf of the franchisor to improve the product and service offerings.
Indeed, the franchise disclosure document offers no real insight into the qualitative side of a franchise. It won’t tell you the full list of franchise support personnel, nor will it tell you the marketing programs they offer to help franchise owners get customers in the door.
But that’s no reason to gloss over the franchise disclosure document review phase entirely. When you take the time to read and understand the FDD in its entirety, you will gain valuable insights into the quality of the franchisor that you will not find anywhere else.
I read, on average, about 100-200 franchise disclosure documents in any given calendar year, which includes the brands I investigate for personal investments, along with the brands that I consider for representation within the Raintree brand. To learn more about the brands in Raintree’s portfolio and how we set ourselves apart as leaders in national franchise sales, read about our unique approach to franchise development here.
All FDDs share roughly the same format and are made up of 23 items. After years of practice, I can scan them for red flags and promising opportunities fairly quickly.
This table offers basic understanding of the 23 items, which you’ll need in order to appreciate the types of red flags that I look for:
|1||The Franchisor, Its Predecessors and Affiliates||contextual, provides a short history of the franchisor and a high-level overview of the business|
|2||Corporate Officers||a brief five-year biography for officers, directors, owners and top executives|
|3||Litigation||The complete list of any past or pending litigation involving the franchisor over the past ten years. If nothing is listed, then this indicates that there are no lawsuits.|
|4||Bankruptcy||a list of any bankruptcies over the past 10 years for the franchisor and/or any owners, employees, or affiliates|
|5||Initial Franchise Fee||the amount and payment terms for the initial franchise fee and any other prepayments (such as real estate and construction fees|
|6||Other Fees||the recurring fees and additional payments (such as local advertising fees and national ad funds) that franchise owners are responsible for, along with an explanation of how those fees have been calculated|
|7||Estimated Initial Investment||a table that summarizes the anticipated low-end and high-end ranges for the investment you should expect to make to get the business up and running|
|8||Restrictions on Sources of Products and Services||the complete list of products/services the franchise owners must purchase from the franchisor or a designated supplier, and whether the franchisor receives revenue from the sale of those products/services|
|9||Franchisee's Obligations||a table that covers all the things you’re responsible for as a franchise owner in order to get the business started|
|10||Financing Options||a description of any financing offerings the franchisor may be providing directly (but remember that this item will not list any banking or 3rd party financing relationships)|
|11||Franchisor’s Assistance, Advertising, Computer Systems, and Training||the complete list of all services the franchisor will perform, along with the resources provided, to help you become successful|
|12||Territory||clearly details the minimum amount of geographical area you will be granted in which you are legally allowed to operate the franchise (note that depending on the type of franchise and the franchisor, franchisees may not be awarded an exclusive territory)|
|13||Trademarks||a list of all trademarks the franchisor has secured for the brand|
|14||Patents, Copyrights and Proprietary Information||the legal rights that a franchisor has over any intellectual property, including common law copyrights and trade sections that franchisor claims to own|
|15||Obligation to Participate in the Actual Operation of the Franchise||makes clear any obligations regarding whether you, as the franchise owner, are required to work full-time in the business or if semi-absentee or entirely passive ownership is permitted|
|16||Restrictions on What the Franchise May Sell||clearly explains obligations to sell only the goods and services that the franchisor provides, which preserves the standards and consistency of the brand|
|17||Renewal, Termination, Transfer and Dispute Resolution||discusses all possible end-game scenarios for the franchise owner, including how long the agreement lasts; options for extending the agreement, selling your franchise, and under what terms the franchisor might terminate the agreement|
|18||Arrangements with Public Figures||notes any business relationships the franchise brand has with a public figure and notes the rules surrounding how franchise owners may or may not be able to use the name|
|19||Financing Performance Representations||requires the disclosure of earnings for either corporate locations, franchise locations, or both (note that there might not be any earnings representation, as this depends on the brand’s level of franchise development)|
|20||Outlets and Franchisee Information||includes five tables providing the last three years of information of the franchise system, including franchise owner growth, corporate growth, transfers, terminations and projections of new openings|
|21||Financing Statements||The franchisor's previous two years of balance sheets and income statements for the previous three years; these are audited financials that must follow generally accepted accounting principle|
|22||Contracts||Includes copies of all documents you need to sign in this section including franchise agreements & lease agreements|
|23||Receipt||a one-pager that states you acknowledge receiving the franchise disclosure document|
To read your franchise disclosure document like a pro, you’ll need to understand how the content under each of these items can influence your working relationship with the franchisor.
Here’s what my decades of experience have taught me:
ITEM 1 (The Franchisor, Its Predecessors and Affiliates)
ITEM 2 (Corporate Officers)
ITEM 3 (Litigation)
ITEM 4 (Bankruptcy)
ITEM 5 (Initial Franchise Fee)
ITEM 6 (Other Fees)
ITEM 7 (Estimated Initial Investment)
ITEM 8 (Restrictions on Sources of Products & Services)
ITEM 9 (Franchisee’s Obligations)
ITEM 10 (Financing Options)
ITEM 11 (Franchisor’s Assistance, Advertising, Computer Systems and Training)
ITEM 12 (Territory)
ITEM 13 (Trademarks)
ITEM 14 (Patents, Copyrights and Proprietary Information)
ITEM 15 (Obligation to Participate in the Actual Operation of the Franchise Business)
ITEM 16 (Restrictions on What the Franchise May Sell)
ITEM 17 (Renewal, Termination, Transfer and Dispute Resolution)
ITEM 18 (Arrangements with Public Figures)
ITEM 19 (Financial Performance Representations)
ITEM 20 (Outlets and Franchisee Information)
ITEM 21 (Financial Statements)
ITEM 22 (Contracts)
ITEM 23 (Receipt)
As you can see the franchise disclosure document fills in the blanks for a lot of the questions that you might have. But this document still may not provide the complete picture of whether the brand is right for you. Many people drop out at this step simply because they find the legalese in this document too overwhelming, even if this step doesn’t require the establishment of a legal relationship or obligation.
Individuals who are able to appreciate the necessity of the franchise disclosure document and respect the intention behind its main objectives are the individuals who go on to investigate the merits of working with that particular brand, and ultimately the ones who benefit from becoming franchisees.
Taking the tips above, remember to review the franchise disclosure document from a business partnership standpoint. As you identify any points in the FDD that bring confusion or concern, note them down, and ask those questions directly to the franchise representative. After having your questions answered, if you feel that the concerns from a business partnership standpoint remain strong, it might be time to move on to the next franchise brand.
From a legal review standpoint, it’s best to wait until you are closer to being approved before you engage the services of a franchise attorney. You don’t want to spend a few thousand dollars for legal work, only to find out you’re not going to be a fit for the brand.
At Raintree, we see about 20-30% of the candidates engage the services of an attorney for a review of the franchise disclosure document. This is primarily because our candidates know the FDD is non-negotiable. We ensure equality for every franchise owner in ensuring they all sign the same franchise agreement.
If you do feel like you want an attorney to review the document, it is HIGHLY recommended you use a franchise-specific attorney. The average attorney won’t understand the nuances of the franchisor/franchisee relationship, and ultimately, you’ll be wasting your money by having a regular attorney comment on something they don’t understand.
Lastly, remember that if you’re moving on to the next phase, don’t forget you list of key questions/concerns here. Especially in relation to Item 7, and Item 19. You’ll do very well to verify these by hearing directly from the franchise owners themselves.
To learn more about Raintree brands and what makes Raintree a leader in national franchise sales, visit our website today and read about the top-tier emerging brands we represent. Our franchise development experts and top franchise consultants are devoted to fostering healthy and sustainable franchise growth by matching quality brands with quality franchise owners.