If you’re thinking about becoming a franchisee, there’s no question that you’ll have your fair share of paperwork to review and complete. But one of the most intensive packets you’ll probably receive as a potential franchisee is the Franchise Disclosure Document, or FDD for short.
Mandated by the Federal Trade Commission, the FDD is a comprehensive overview of a franchisor’s brand, business model and the obligations of the franchisor and its franchisees. It can run hundreds of pages long, but it’s key to understanding a brand, how it works, and what’s expected of you before signing on the dotted line.
There are 23 categories that must be included in an FDD. It may feel intimidating, but here are a few tips for what to look for in a FDD. Pay specific attention to items 9, 11, 19 and 20 when making your decision.
- The Franchisor, Its Predecessors and Affiliates – Overview of the franchisor’s history, ownership and corporate family, including the types of franchises offered.
- Business Experience – Reviews the franchisor’s leadership team and their experience in management and franchising. Look for a strong team with solid franchising experience.
- Litigation – Reveals if the company and its directors have been involved in any lawsuits. Companies with multiple franchisees alleging fraud or misrepresentation may signal problematic issues within the franchise.
- Bankruptcy – Discloses if the company and/or its directors have been in bankruptcy.
- Initial Franchise Fee – How much it costs to become a franchisee. This fee may be negotiable, especially if a dollar range is listed — so ask if you qualify for a lower fee.
- Other Fees – Lists other costs associated with owning a franchise, such as royalty and advertising fees.
- Initial Investment – Lays out fees and expenses required to open and run a location for the first three months. However, the number listed here may be an underestimation of the money needed to float your business until it generates a profit.
- Restrictions on Sources of Products – The products and services sold at each location must meet the franchise’s standards. For that reason, the FDD identifies the pre-approved suppliers.
- Franchisee’s Obligations – Probably the most important section in the FDD, this reviews your contractual obligations in accordance with the franchise agreement. If this section is inconsistent with the franchise agreement, it may be a red flag.
- Financing – Tells you if the franchisor offers a lending program, or if they partner with other lenders for financing. Remember, you’ll not only have to meet the franchisor’s requirements, but also the lender’s criteria for financing.
- Franchisor’s Obligations – Describes the type of support the franchise offers to location owners, such as training, advertising, computer systems, etc. Words like “as needed” or “at our discretion” signal that the services may not be available for everyone.
- Territory – Identifies which territories are available and ensures you’re not directly competing against other franchisees of the same brand.
- Trademarks – Lists the trademarks and registration the franchisor has obtained.
- Patents, Copyrights, and Proprietary Information – Lists the patents and copyrights that belong to the franchisor.
- Obligation to Participate in the Actual Operation of the Franchised Business – Reveals whether or not you must be a full-time owner of the franchise or if passive ownership is acceptable.
- Restrictions on What the Franchisee May Sell – States exactly what each franchise can sell, based on what the franchisor allows.
- Renewal, Termination, Transfer, and Dispute Resolution – A summary of the relationship between franchisor and franchisee, including terms of renewal and termination, and how any disputes will be resolved.
- Public Figures – Only relevant if the franchise uses public figures in advertising.
- Earnings Claims – Provides estimates of how much current franchisees are earning. However, franchises can also choose not to make such a claim in the FDD.
- List of Franchise Outlets – The number of franchises opened, transferred and closed in the last three years. This section also includes a list of current and former franchisees. It’s always wise to contact several to learn about their experience.
- Financial Statements – Audited financial statements that allow you to see if the business in stable. An accountant may be necessary to fully understand these numbers.
- Contracts – The documents necessary to sign if you become a franchisee.
- Receipts – Copies of contracts you’ve signed. Remember to keep all receipts for your records.