When you’re evaluating a franchise for purchase, one of the documents the franchisor will share with you is the franchise disclosure document (FDD). This document, which is also known as a uniform franchise offering circular (UFOC), is a 50-plus page legal disclosure that describes the roles and responsibilities of both the franchisor and franchisee. It also explains the franchisor’s background, legal, and financial positioning and other important topics.
Put simply, this document contains almost everything you need to know about the business. With it, you’ll be able to assess whether a franchise opportunity is worth the significant investment that’s required.
Why do franchisors provide a franchise disclosure document?
The Federal Trade Commission (FTC) requires franchisors to provide a standard franchise disclosure document to prospective franchisees as part of their presale due diligence process.
Franchisors must share the franchise disclosure document with potential owners at least 14 days before they sign a binding agreement or provide an initial payment (whichever occurs first). They must also share the contracts that a franchise owner will need to sign at least five days before they’re required for submission.
You can read the FTC’s Franchise Rule here.
What can I expect to find in the franchise disclosure document?
The FTC lays out the precise information a franchise disclosure document should include. Their goal is to help potential franchisees have a clear understanding of the business and its performance and history. Among other important topics, the franchise disclosure document must explain:
- The size of the franchise
- The franchise’s growth trends
- The franchise’s financial performance
- The backgrounds and experiences of the franchisor’s leadership team
- The upfront and ongoing costs of buying into the franchise
- The training and support that is available to franchisees
In many cases, the franchise disclosure document won’t provide information about the performance of individual franchise units, profit or loss expectations, or reasons for unit closures. However, it’s usually possible to attain this information from other sources. Many find data through the company’s public filings, annual reports, and third-party franchise intelligence sites.
What should I look for in parts of the franchise disclosure document?
There are 23 sections in the franchise disclosure document. Each part contains information that every potential franchise owner should consider before investing. Use this chart, which dissects the parts of the franchise disclosure document, to find some key points:
Item 1 | The franchisor and any parents, predecessors, and affiliates
In this section, the company will describe itself and its history, which may include the number of times the business has been bought or sold since its founding.
What to look for: consistency in both the ownership and the purpose of the business
While it’s normal for a business to change hands, you might want to use caution with a franchise that changes hands often or has changed hands too recently to assess how the new team will change its trajectory.
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Item 2 | Business experience
This section includes background information on the franchisor, officers, directors, and executives.
What to look for: expertise
Read this section carefully to understand the qualifications of each member of the leadership team. These members are the business’s key decision-makers, and they’ll lean on their personal backgrounds and experiences to set the direction for the franchise and franchise owners.
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Item 3 | Litigation
This section contains an overview of the civil, criminal, and class action cases impacting the business or its key personnel over the past five years.
What to look for: few to no past cases, open cases, or mentions of fraud or misrepresentation
You’ll want to see few closed or outstanding cases in relation to the number of franchises the business supports. And, ideally, you won’t find cases that involve concerns from franchisees over misrepresentation of what they bought by buying into the franchise.
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Item 4 | Bankruptcy
In this section, you can learn whether the franchisor or any of its key personnel has filed for bankruptcy.
What to look for: recent filings
If you spot any instances of bankruptcy filings in this section of the FDD, you should bring them up with the franchisor. Ask about the reason behind corporate bankruptcy filings. Then, try to assess whether the filing improved the strength of the business.
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Item 5 | Initial fees
This section describes the fees that a franchisee must account for when starting a new unit.
What to look for: an explanation of fees or fee range and factors that determine the fees an owner will pay
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Item 6 | Other fees
This section spells out the fees that a franchisee can expect to pay after taking ownership of a franchise unit.
What to look for: high ongoing costs
Many franchisees must pay ongoing royalties to the franchisor. Some also must pay licensing fees, marketing expenses, or other fees that make the costs of running a business much higher.
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Item 7 | Estimated initial investment
This section includes the upfront costs that a franchisee will need to cover to start a franchise unit.
What to look for: a full breakdown of costs, which should be offered in a table format
Study the costs for real estate, startup inventory, equipment, signage, advertising, and other elements specific to the franchise to learn how much capital you’ll need to set up a unit. You should also find the franchisor’s recommendation for additional capital to cover other early expenses. It typically amounts to an additional 10% of the initial investment costs.
A word of caution: Some franchisors lowball their estimates of additional capital to attract investors. Very low estimates can signify that the franchisor is more interested in attaining upfront investments from franchisees rather than setting them up for long-term success.
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Item 8 | Restrictions on sources of products or services
This section describes the standards and limitations the franchisor has set on how franchisees can source the goods or services needed to run their units.
What to look for: disclosure of whether the franchisor requires its unit owners to buy from a vendor who offers the franchisor rebates, revenue, or other consideration
Franchisors who engage in this practice may force franchisees to purchase their inputs at a higher-than-necessary price so they can receive a kickback from the transaction. This practice can make running a profitable franchise unit much more difficult.
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Item 9 | Franchisee’s obligations
This section describes the terms that the franchisee must agree to in order to own a franchise unit.
What to look for: reasonable terms
The FTC requires that this section (and every other part) of the FDD be written in plain English. Be sure to review the terms thoroughly. Ask the franchisor and your attorney about any parts that seem unclear or unreasonable.
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Item 10 | Financing
This section should outline the financing arrangements the franchisor offers.
What to look for: options that may help you come up with the capital you need to begin running a franchise unit
Some franchisors team with outside financial institutions to provide 401(k) business funding, SBA loans, portfolio loans, and unsecured loans that could help you spread the upfront costs over a period of years rather than parting with a large lump sum upfront. Many also offer another kind of financing called franchisor financing that’s often worth considering.
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Item 11 | Franchisor’s assistance, advertising, computer systems, and training
This section describes the services the franchisor will offer to franchisees to help with startup and continued operations.
What to look for: classes, coaching, and support lines that will help you to get up to speed quickly and marketing collateral that’ll help you to attract and retain a solid customer base
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Item 12 | Territory
In this section, the franchisor will explain how it defines, modifies, and protects territories.
What to look for: indications of whether territory exclusivity is offered; whether the franchisor has other ways to distribute its products in assigned territories; and whether there are restrictions on the distance between units
Some franchisors set limits that are based on distances. Here, two franchise units may not be located within a set number of miles or city blocks from one another. Others may set limits based on the size of the surrounding population rather than the distance between units. Make sure that you understand these rules today, and be sure to read the disclosures on how they can change over time.
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Item 13 | Trademarks
This section discusses the franchisor’s trademarks, service, and trade names.
What to look for: verification that the franchisor owns its name and the marks it uses and that it’s able to assign rights of usage to franchisees
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Item 14 | Patents, copyrights, and proprietary information
This section explains the intellectual property that the franchisor owns and how it can be used by the franchisee.
What to look for: specific stipulations on how patents can be used, how proprietary information can be accessed and stored, and whether copyrighted material can be replicated or adapted for use by a franchise unit
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Item 15 | Obligation to participate in the actual operation of the franchise business
This section describes the role the franchisee must play in running the business.
What to look for: details on the responsibilities of the franchisee and the repercussions you could face for failing to comply
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Item 16 | Restrictions on what the franchisee may sell
This section spells out the specific products and services that a franchise unit may or may not offer.
What to look for: gray areas and indications of whether a franchisee may make product or service recommendations to the franchisor
Make sure that you assess these restrictions in their entirety and ask the franchise representative for any clarification that’s needed.
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Item 17 | Renewal, termination, transfer, and dispute resolution
This section describes the terms under which a franchise may be continued or terminated. It should also explain the actions you can take if you have a disagreement with the franchisor.
What to look for: when and how the franchisor can end your relationship with their business and the process you’ll need to follow to settle disputes
You may find requirements for arbitration or mediation to resolve issues and the processes that franchisees must follow to file legal claims against the business.
A word of caution: Many franchisors require litigation to be brought forth in a site of their choosing. Generally, these sites have notoriously high costs for suing and often favor big businesses, including franchisors, in settlements.
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Item 18 | Public figures
This section discloses the names of any celebrities or known figures who are paid representatives of the brand.
What to look for: the identities and payment amounts of each representative
Take note of who is serving as the voice of the brand and consider how much value they could bring to a franchise unit. Then, try to calculate the cost that each unit figuratively pays for that representation. You can do this by dividing the representative’s total compensation by the number of franchise units.
There isn’t much you can do if you find that a sponsor is being paid—in your estimation—too much for their services. Still, you can get a sense of how the franchise values building its brand and connecting with its audience through relevant public figures.
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Item 19 | Financial performance representations
This section, which is voluntary, may include information on each unit’s (or an average unit’s) financial performance.
What to look for: sales volumes and profitability
Because this section is voluntary, it’s up to the franchisor to determine what to disclose and how to disclose it. Be sure to read through any sales, revenue, and gross margin figures they offer, and refer to this information as you determine how viable a franchise unit might be.
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Item 20 | Outlets and franchisee information
This section contains information on how the number of franchise units has changed over the past three years. It also includes the locations and contact information for each existing franchise unit.
What to look for: indications of growth or contraction
Read this section to learn how many units closed, were terminated, or did not renew their contract over the three-year period. You should also look into how many units were reacquired by the franchisor or transferred to other owners. This could signify that franchisees find it difficult to fulfill the franchisor’s requirements.
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Item 21 | Financial statements
This section includes three years of audited financial statements for the franchisor.
What to look for: indications of the franchisor’s financial health
Review the balance sheets, statements of operations, owner’s equity, and cash flows provided in this section with an accountant. Your accountant can help you understand the financial strength of the business, project future earnings, and find underlying problems.
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Item 22 | Contracts
This section contains the agreements that franchisees must sign.
What to look for: financing, licensing, and supply chain agreements and guarantees made by the franchisor or key member of the franchisor’s team
This section should be reviewed by an attorney who can help you understand the terms and conditions.
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Item 23 | Receipts
This section includes a signature line for franchisees to acknowledge that they’ve received the FDD. It may also restate certain disclosures or decisions made between the franchisor and franchisee and provide additional information.
What to look for: terms and conditions of franchise unit ownership that were not provided in other parts of the FDD
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Should I have an attorney review the franchise disclosure document?
Yes. You should share it with an attorney who can help you understand the terms and conditions of franchise unit ownership.
Need help finding an attorney? Consider working with Contract Counsel. Check out their website here.
You should also share the document with an experienced small business accountant who can help you make sense of the financial strength and stability of the franchisor’s business.
These accounting firms are some that other business owners love to work with. Learn more about them here:
Reconciled
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Read these articles to learn more:
What’s next?
Plan to attend the franchisor’s discovery day. This in-person event allows potential franchisees to learn more about the brand, the business, and the management team’s plan to help their franchisees succeed. You can learn more about this event here:
Ready to move forward? We can help. Log into your owner’s portal for a step-by-step guide that’ll help you evaluate any franchise you consider, attain financing, and conduct the work that’s needed to make your venture a success.
