Why the FDD Is Essential for Franchise Buyers

To put it in the starkest terms possible, when evaluating a franchise opportunity, nothing is more important than your review and understanding of a brand’s franchise disclosure document (FDD). First and foremost, FDDs are governed by the Federal Trade Commission‘s (FTC) “Franchise Rule,” a provision that instructs all franchisors to provide a copy of their FDD to potential candidates no less than 14 calendar days before an agreement is reached or money changes hands. So, two weeks in the minimum amount of time that must pass before a decision on purchasing. In reality, you should take all the time you need. The FDD may be a snoozefest, but it’s critical that you buckle down and read it — carefully.

Before we drill down to learn more about the individual sections of an FDD, it’s highly advisable for those reviewing this document to enlist the help of a qualified franchise attorney or CPA who can assist with comprehending the information included therein.

Related: Considering franchise ownership? Get started now to find your personalized list of franchises that match your lifestyle, interests and budget.

All about transparency

The FTC-regulated franchise disclosure document is designed to ensure potential candidates get an open, honest, and transparent look at the franchise opportunity being presented. Often hundreds of pages long, this legal document is divided into 23 different sections, referred to as “Items” in the franchising industry. Each section includes its own proprietary information about the brand, designed to ensure candidates are provided with everything they need to make an informed decision about moving forward in the buying process.

FDDs aren’t supposed to be biased. In fact, there are sections that require franchisors to disclose certain information whether it’s flattering or not. The FTC wants to make sure that potential candidates know exactly what they’re getting into when considering franchise ownership. And that can only be accomplished with transparency. What follows is a breakdown of the individual items included in the FDDs, grouped according to the information provided.

Related: The 23 Items Your Franchise Disclosure Document Must Include

How to Read and Evaluate Items 1-4

Designed to provide candidates with the franchisor’s basic information, items one through four include the brand’s history, timeline, and overview of the company. You’ll discover who the founders and executives are, along with bios that list their career experience. Items 3 and 4 should be of utmost interest to potential candidates, as its here where franchisors are duty bound to disclose whether there are any past or current litigation matters, or bankruptcy filings attributed either to the company or its personnel.

Discover the True Cost in Items 5-7

When evaluating a particular franchise concept, you’ll know up front about the initial franchise fee, net worth requirement, total investment range, and the percentage of gross sales you’ll be kicking back to the franchisor in the form of royalty payments. But Items 5-7 instruct franchisors to disclose any and all fees associated with purchasing the franchise. That includes other significant expenses such as any marketing, promotional, or advertising co-op fees, technology fees, and the costs involved in renewals or transfers. The data must be presented in clear, tabular form, and Item 7 is reserved for laying out the projected fees and expenses of operating the business for the first three months.

Significant Items – 9, 11, and 12

These items have been singled out due to their importance, with further explanations below:

• Item 9 – This item spells out the roles and responsibilities of franchisor and franchisee alike.
• Item 11 – This section references the comprehensive support programs provided by the franchisor.
• Item 12 – This section provides the franchisor’s definition of what they consider an exclusive or protected territory.

Related: Location Is Everything — Especially in Franchising. These Are the Territory Rules You Need to Know

Quick-Hitters on Items 13, 14, and 17

As we progress towards the magic number 23, take a moment to review these quick-hitting definitions of a few more significant Items included in the FDD:

• Items 13-14 – This is the section that discloses the franchisor’s trademarks, copyright registrations, and patents – both pending and secured.

• Item 17 – This is the section that will give you the answer to everything related to renewals, terminations, breach of contract, transfers, and how disputes are resolved (shocker: most demand out-of-court mediation).

Related: Looking to Figure Out How Much You’ll Make as a Franchisee? Consider These Factors.

Now…the money

Item 19 is by far a unanimous choice as the most popular section of the FDD, as it involves the brand’s financial representations and performance claims. This section tends to draw the most attention from potential franchisees because they always want to know how much money they can make as an owner in the system. Let’s break down how to evaluate Item 19 like a pro:

• Item 19 typically includes representations of potential revenue and expenses, but expect to see plenty of lengthy legal disclaimers.
• Pay close attention to financial performance figures from corporate-owned locations vs. awarded franchisee-owned units — there is often disparity there, as corporate-owned units are exempt from royalty payments and may enjoy other discounted breaks on labor, leasing, and inventory.
• It’s common for franchisors to pull positive financial data and figures from the top-performing units in the network, which you should probably have assumed in the first place.

An important note to reiterate is that franchisors are prohibited from making any financial or revenue-related claims — written or verbal — that aren’t included in Item 19.

From here, the remaining Items are fairly mundane. Item 20 will tell you how many locations, either corporate or franchisee-owned, have been awarded to date. Item 21 provides audited financial statements. And the final two sections include all contracts you’ll be required to sign as part of the purchasing process (Item 22) and your official receipts (Item 23).

Do your due diligence and don’t rush these steps. Evaluating a franchisor’s FDD should be taken as seriously as possible — because there’s a reason the second letter in the acronym itself refers to “disclosure.”