Your Guide to Reading a Franchise Disclosure Document

A person sits on a couch and reads a franchise disclosure document

When you are 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 document that describes the roles and responsibilities of both the franchisor and franchisee, as well as the franchisor’s background and legal and financial positioning. This document is a legal disclosure that 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 FDD to prospective franchisees as part of their presale due diligence process. Franchisors must share the FDD with potential owners at least 14 days before they sign a binding agreement or provide an initial payment (whichever occurs first), and they must share the contracts that a franchise owner must 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 specifies the precise information that the FDD should include to ensure that potential franchisees have a clear understanding of the business and its performance and history. Among other important topics, the FDD 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 FDD won’t provide information about the performance of individual franchise units, profit or loss expectations, or reasons for unit closures. However, you may be able to attain this information from other sources, including the company’s public filings, annual reports, and third-party franchise intelligence sites.

 

What should I look for in the parts of the franchise disclosure document?

There are 23 sections in the FDD, and each part contains information that every potential franchise owner should consider before investing. The following chart dissects the parts of the FDD and the information that will be most relevant to your research:

Item 1

The franchisor and any parents, predecessors, and affiliates

 

In this section, you’ll find a description of the company 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 may want to use caution with a franchise that changes hands often or has changed hands too recently to determine how new personnel will change the trajectory of the business.

 

Item 2

Business experience

 

This section includes background information about 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.

 

Item 3

Litigation

 

This section contains an overview of the civil, criminal, and class action cases that are impacting or have impacted the business or its key personnel over the past five years.

 

What to look for: a minimal number of past cases, open cases, and 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 you’ll want to ensure that few to none of the cases involve concerns from franchisees over misrepresentation of what they bought by buying into the franchise.

 

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 in your discussions with the franchisor. Ask about the reason behind corporate bankruptcy filings, and try to assess whether the filing improved the strength of the business.

 

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 the range and factors that determine the fees a franchisee will pay

 

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 are expected to pay ongoing royalties to the franchisor, but depending on the franchise, franchisees may also be expected to pay licensing fees, marketing expenses, or other fees that make the costs of running a business significantly higher.

 

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 provided in a table format

 

Examine the costs for real estate, startup inventory, equipment, signage, advertising fees, and other elements specific to the franchise to understand how much capital you’ll need to establish a unit. You should also find the franchisor’s recommendation for additional capital to cover other early expenses, which 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 in their unit.

 

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 that the franchisor can receive a kickback from the transaction. From the franchisee’s perspective, this practice can make running a profitable franchise unit significantly more difficult.

 

Item 9

Franchisee’s obligations

 

This section describes the terms that the franchisee must agree to in order to take ownership of 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, and ask the franchisor and your attorney about any elements that seem unclear or unreasonable.

 

Item 10

Financing

 

This section provides an overview of the financing arrangements the franchisor offers.

 

What to look for: options that may help you come up with the capital you need to begin operations

 

Some franchisors team with outside financial institutions to provide 401(k) business funding, SBA loans, portfolio loans, and unsecured loans that may help you spread the upfront costs over a period of years rather than parting with a large lump sum in a single transaction.

 

Item 11

Franchisor’s assistance, advertising, computer systems, and training

 

This section describes the services the franchisor will offer to franchisees to help with the startup and continued operations of the business.

 

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

 

Item 12

Territory

 

In this section, the franchisor will explain how territories are defined, modified, and protected.

 

What to look for: indications of whether territory exclusivity is offered; whether the franchisor has other means of distributing its products in assigned territories; and whether there are restrictions on the distance between units

 

Some franchisors set limits that are based on distances, where 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, and be sure to read the disclosures that cover how territory rules may change over time.

 

Item 13

Trademarks

 

This section discusses the franchisor’s trademarks, service, and trade names.

 

What to look for: verification that the franchisor has ownership of their name and the marks that they use and that they are able to assign rights of usage to franchisees

 

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

 

Item 15

Obligation to participate in the actual operation of the franchise business

 

This section describes the role the franchisee must commit to playing in the operational aspects of the business.

 

What to look for: details on the responsibilities of the franchisee and the repercussions you may face for failing to comply with those responsibilities

 

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.

 

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: the conditions under which 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 take to file legal claims against the entity.

 

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.

 

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. Compare your estimation with the cost that each unit figuratively pays for that representation, which you can achieve 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. However, you can get a sense of how the franchise values building its brand and connecting with its audience through relevant public figures.

 

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 is up to the franchisor to determine what information to disclose and the manner in which they’d like to disclose it. Be sure to read through any sales, revenue, and gross margin figures that they offer, and refer to this information as you assess the financial viability of owning a franchise unit.

 

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 determine how many units ceased operations, 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, which could signify that franchisees find it difficult to fulfill the franchisor’s requirements.

 

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 a professional accountant. Your accountant can help you make sense of the financial strength of the business, project future earnings, and find indications of underlying problems.

 

Item 22

Contracts

 

This section contains the agreements that franchisees are required to 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 of franchise unit ownership.

 

Item 23

Receipts

 

This section includes a signature line for prospective 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

 

Should I have an attorney review this document?

Yes. You should share the FDD with a small business attorney who can help you understand the terms and conditions of franchise unit ownership. Additionally, you should 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.

Would you like to connect with an attorney or an accountant? Click the buttons below to get started:

Read these articles to learn more:

 

What’s next?

Plan to attend the franchisor’s discovery day, an in-person event that 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 in our guide, What Is Discovery Day and How Should I Prepare?.

Ready to move forward? We can help. Log into your owner’s portal for a step-by-step guide, resources, and articles that’ll help you evaluate any franchise you consider, attain financing, and conduct the work that’s needed to make your venture a success.

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