As you Buy a Franchise or think about Buying a Franchise the FDD Review is crucial! This is a thorough FDD Review, where I go through EVERY Item in the FDD (Franchise Disclosure Document).
So check it out below!
First things first, so what is an FDD? FDD stands for Franchise Disclosure document and it’s a legal disclosure document that is required of ALL franchises in the U.S. Usually after a couple of conversations with a franchisor - they will send you the FDD to review, and ask you to sign it. Signing it is just acknowledging receipt - that’s it, and you need to do this 14 days prior.
Franchises are regulated by the FTC- Federal Trade Commission and each FDD follows 23 disclosure sections. Required by federal law, the FDD contains 23 disclosure sections (each section is called an “item”) that contains detailed information about the franchisor, the franchise system and the franchise opportunity that you may be buying into. In addition to the franchise investment disclosures contained in the FDD, the FDD also includes a copy of the franchise agreement and other legal documents that you will be required to sign when you become a franchisee.
There are 21 - what’s called “Items” or sections in the FDD - A couple of really important ones are Item 1, Item 7, Item 12, Item 15, 19, 20 and 21. BUT THEY ARE ALL IMPORTANT.
Seriously don’t get so excited and ready to pull the trigger without doing a thorough review of the FDD, and documenting all of your questions and concerns. READ below to get familiar with all 23 items/sections.
Item 1: The Franchisor – This provides information about the franchisor, the franchisor’s predecessors and its affiliates. This will provide the history of the Franchisor, and it could lead to learning some red flags- or feeling more comfortable about the business. Read it and note any questions you have for the Franchisor.
Item 2: Business Experience – This lists the top executives within the franchise system, and their roles, responsibilities and backgrounds. Note their experience in business and in franchising specifically. The leadership team running the Franchisor, will be the single-most major factor in the overall success of the brand.
Item 3: Litigation – This provides information about current and prior litigation (lawsuits) within the last 10 years. Generally this will only list lawsuits that specifically pertain to franchising and franchisors, or state agencies. Look for any pattern here, and frequency of litigation. This can be a red flag. Lawsuits are serious- if individuals or agencies are consistently taking time and money to enter into litigation, you need to research and investigate this.
Item 4: Bankruptcy – This provides information on whether or not the franchisor or its predecessors or members of its management team have previously filed for bankruptcy.
Item 5: Initial Fees – This provides information about the various fees that you will be required to pay to the franchisor. You’ll see fees like the one time initial fee, and many others.
Item 6: Other Fees – This provides insight on fees that you will be required to pay to the franchisor. This section will typically include ongoing royalties, marketing fees, technology, and more. These fees are important to understanding because they will impact your profitability or lack thereof in your franchise.
Item 7: Estimated Initial Investment – This is a comprehensive list of all the expected and potential costs involved in opening your franchise. This is a range that’s provided, including additional funds to set aside for the first 6 months or so of operation. This is the most detailed outlay of what your initial investment could or would be to get your franchise open. Note that it’s wise to estimate on the higher end unless you have tangible reasons to believe you will be on the lower end of the investment.
Item 8: Restrictions on Sources of Products and Services – This provides information about the products and services that you may or may not sell from the franchised business. This will typically include details about specific products and services that the franchisor requires you to purchase either directly from the franchisor or the franchisor’s designated and exclusive suppliers. The information in this item is important to understand the supply chain side of the business, and how that could impact your finances. It will also list when the Franchisor may receive kick-backs, or revenue from supplies or products provided.
Item 9: Franchisee’s Obligations – This provides details about your legal obligations and rights as a franchisee under the franchise agreement. This includes things like renewal rights, non-compete restrictions, confidentiality requirements, termination rights and choice of law and forum selection provisions.
Item 10: Financing – This provides information on whether or not the franchisor provides financing or not.
Item 11: Franchisor’s Assistance, Advertising, Computer Systems and Training – This Item explains the support and assistance the franchisor will provide prior to the opening of the franchised business and on a continual basis after the franchised business is opened. This item also covers what specific software or technology you must use as a franchisee, and disclose the franchisor's access to data. It will also discuss your obligations in the site selection process, and other phases of the pre, mid, and post opening process.
Item 12: Territory – This item details the radius or area that a franchisee can operate their business in. It also discloses whether another franchisee, or even the franchisor can operate within the territory. This is an important factor to read through and understand, because another franchise business operating close to you could potentially impact your ability to succeed with your franchise business.
Item 13: Trademarks – This is an important one! It contains information about franchisor’s primary trademarks and whether or not these trademarks are legally protected and registered with the United States Patent and Trademark Office. If the franchisor is aware of any challenge to the Franchisor’s trademarks, they should include other disclosures about it here.
Item 14: Patents, Copyrights, and Proprietary Information – This item contains information about other intellectual property assets that the franchisor may or may not possess. Within Item 14 franchisors are required to disclose information about any advantage or asset related to a patent or copyright, as well as proprietary information being the confidential operations manual.
Item 15: Obligation to Participate in the Actual Operation of the Franchise Business – Read this one twice! It contains important information about whether you, personally, as the franchisee are required to participate in the every day operation and management or whether you may depend on employee managers. Item 15 specifies whether or not a franchisee must be an owner operator or if it may be an absentee owner.
Item 16: Restrictions on what the Franchisee may Sell – Typically, franchisors will maintain full control over what may or may not be offered. This item contains information about the degree of control you will be given as a franchisee over the products and services that you may or may not offer from the franchised business.
Item 17: Renewal, Termination, Transfer and Dispute Resolution – This one includes a detailed chart that references to provisions in the franchise agreement and summarizes core legal rights that you will be granted. Those rights are: - the length of the franchise agreement, - renewal rights, - events allowing the franchisor to terminate the franchise agreement, - franchisee rights, - non-compete obligations, - whether or not the franchise agreement contains dispute resolutions and the applicable state law and state forums that govern in the event of a dispute between the franchisor and franchisee.
Item 18: Public Figures – This item includes all information describing franchisor paying any public figures to promote the franchise and whether or not these public figures are a part of the franchisor’s management team.
Item 19: Financial Performance Representations – Provides information as to whether or not the franchisor makes a financial performance representation. A financial performance representation is when a Franchisor provides information around franchised or corporate owned locations. Financial performance representations can include information about gross sales, EBITDA and other financial metrics. Franchisors are not allow to make any other financial performance representations unless they are specifically included in Item 19. ( So no, they can't tell you how much money you can make!)
Item 20: Outlets and Franchisee Information – Item 20 includes several tables summarizing the three year history of the franchisors corporate owned outlets and franchised outlets. You will find all the information about outlets that have been opened, closed, transferred and terminated. It will also include detailed information about current and former franchisees.
Item 21: Financial Statements – This is a financial statement of the franchise company. For established franchisors, this item has to include three years of complete and audited financial statements. New and start-up franchisors will have more limited financial statements.
Item 22: Contracts – This item is a list of all the legal agreements and contracts attached to the FDD. The primary contract is the franchise agreement.
Item 23: Receipts – Last item, in duplicate, is a receipt that the franchisor will ask you to sign. The purpose of this receipt is for the franchisor to record and document the date that franchisor disclosed its FDD to you. FDD’s are commonly delivered electronically and you may be asked to sign an electronic receipt.
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