What is a franchise disclosure document?
The Franchise Disclosure Document (FDD) is a critical legal document that franchisors must give to potential franchisees before signing a franchise agreement.
The Federal Trade Commission governs the contents of the FDD. There are 23 required items in the FDD. A franchisor must supply the FDD 14 calendar days before the franchisee pays any fees or signs a franchise agreement.
A potential franchisee should read the FDD carefully before deciding to invest in a franchise. The FDD uncovers vital information about the franchise system and the franchisor. The FDD will also advise the franchisees of its obligations under the contract.
The following list supplies a basic overview of the 23 items contained in the FDD.
1. The Franchisor and its Parents, Predecessors, and Affiliates
This section provides a simple overview of the Franchisor and its business. Company-owned locations will also be found here.
2. Franchisor’s Business Experience
Item 2 supplies more detail on who runs the franchisor and their business background.
This is an important topic. This section will disclose litigation that the franchisor has been involved in regarding its franchisee relationship in the last fiscal year. While litigation can be common for large companies, it provides insight into potential trouble spots.
Item 4 must show if the franchisor or the individuals in item 2 have filed for bankruptcy in the previous ten years.
5. Initial Fees
The Franchisor’s initial fees to become a franchise are listed in item 5.
6. Other Fees
The item discloses the other fees a franchisee must pay, such as royalty and marketing fees.
7. Estimated Initial Investment
This section will identify an estimate of how much the franchise can expect to incur to start the business (often with a low-high range).
8. Restrictions on Sources of Products and Services
This item will list the products or services the franchise can be required to buy as part of the system.
9. Franchisee’s Obligations
Item 9 lists the franchisee’s legal obligations. Failure to follow these could mean a breach of the franchise agreement.
Sometimes, a franchisor may give referrals for financing or even rarer, provide direct financing itself. Commissions or referral fees will be found here.
11. Franchisor’s Assistance, Advertising, Computer Systems, and Training
Franchisors may sell goods and/or services to their franchisees. These relationships and the revenue earned must be disclosed.
12. Franchise Territory
A potential franchisee should read this item carefully to see how safe their business will be from others in the system.Franchisors need not provide exclusive or protected territory.
Item 13 covers the franchise’s trademarks. Litigation over the marks, if any, will also be disclosed. This section will also discuss special limitations on the marks or if other entities are allowed to use them.
14. Patents, Copyrights, and Proprietary Information
Item 14 refers to the franchise’s patents, copyrights, and other proprietary information.
15. Obligation to Participate in the Actual Operation of the Franchise Business
Item 15 states who can run the franchise unit. Some franchises allow managers to run the business, whereas others require an owner-operator.
16. Restrictions on What the Franchisee May Sell
This item identifies the vendors that franchise must use or other similar restrictions on the business. In some businesses, the franchisee must only buy from approved vendors.
17. Renewal, Termination, Transfer, and Dispute Resolution
Item 17 covers what happens when the franchise is closed and other similar issues. It also covers how disputes are resolved.
18. Public Figures
Item 18 identifies a public figure’s role in the franchise. Think Shaq. These will include the person’s role in sales, management, and their investment in the franchise.
19. Financial Performance Representations
Item 19 is important in evaluating a franchise. Franchisors are not required to provide financial information known as financial performance representations (FPRs). Some franchisors fear representations could be used in a lawsuit from a failed franchisee. However, if a franchisor wants to provide earnings, sales, and expenses data it will be found in item 19.
20. Outlets and Franchisee Information
Item 20 reviews the number of franchises opened, terminated, closed, and transferred in the past 3 years. Contact information is included. A potential franchise should understand why a location closed to help understand the strengths and weaknesses of the franchise.
21. Financial Statements
Item 21 will have three years of audited financial statements from the Franchisor. This item will assist in reviewing the franchisor’s financial condition. Startup franchisors are exempt from this rule and can provide an unaudited balance sheet in the first year of franchising.
All required contracts, including the franchise agreement, will be provided in Item 22. Other contracts can include lease riders, non-compete agreements, and personal guarantees. Review these thoroughly.
Item 23 is simply a receipt page to acknowledge when the FDD was received.
As you perform due diligence of a franchise, make sure that you review the FDD carefully. An attorney can help you wade through the documents and assist you in understanding your investment.