What's Important in a Franchise Disclosure Document?
May 25, 2012
It’s frustrating. A Franchise Disclosure Document is extremely important to read. And equally as boring. This document and the Franchise Agreement set out the complete terms under which you become a franchisee. You might have great conversations with the franchise representative. You might get to know, like, and trust him. But what matters is what’s in writing. If you are considering buying a franchise, you will need to get comfortable with this entire, legal-ease filled document. Let’s start with a description: What exactly is the Franchise Disclosure Document? In the United States, franchises are all regulated by the Federal Trade Commission (FTC). One of the regulations requires every franchise to publish a Franchise Disclosure Document (FDD) every year. Every year the document must be updated with current information. The FTC dictates what information must be included in the FDD. The FTC actually writes the table of contents. They ensure that each franchise company provides the same kinds of information, usually called “items.” There are 23 sections in the FDD. Let’s review of some of the most crucial parts. There will be information on the senior managers of the company. That is something you would want to know. Has there been an ownership change? If so, do the new owners have a background in the industry? Have the owners ever filed bankruptcy? This is the kind of information that will be included on the ownership, in items number one, two, and four. Has this company ever had a major law suit? If so, it will be detailed in the FDD. We all know even the most ethical company can be taken to court in The United States these days. So a single lawsuit might not be a reason to worry. But some franchise companies have literally dozens of suits between them and the individual franchisees. If you see that kind of litigation history you know you could be in for big trouble after joining that franchise. That’s a reason to pay attention to item number three – Litigation. You know you have to make an investment in order to start a franchise, but how much? That’s also in the FDD. The company will give you ranges for every start-up cost that franchisees typically experience: rent and advertising and construction. They’ll tell you how much cash you should have on hand in order to cover your costs after you open. Look at items number five, six, and seven for this information. Most people know that a McDonald’s franchisee must purchase all of their food products directly from the franchiser. Does your franchise have a rule like this? You can find out in items 8 and 16. Some franchises give you a protected territory, while others do not. Neither of these is necessarily “better,” but you’ll want to read item 12 to understand how the territory works in the franchise you are considering. Item 19 is the one that is most often talked about. This is the only optional part of the FDD. In this section, the franchisor is permitted to share the financial results that existing franchisees have. This is obviously important information to have. Unfortunately, only about one-third of franchisors provide this. But don’t worry – if yours does not, there is still a way to get this information. The last item we will mention is usually cited as the most valuable. In Item 20 the franchisor must show you how many franchises they have, as well as how many have opened and closed for the past two years. What’s better is that they also have to provide phone numbers for every last franchisee. Why is this so valuable? Because those franchisees are your best source of information on the business. You can pick up the phone and call as many of the existing franchisees as you like. Whatever you want to know about the business, you can ask them. The existing franchisees will give you an inside look into exactly what it’s like to own this franchise. We find they usually give it to you straight – warts and all. And after all, no one is in a better position to tell you what the business is really like than the people who are working in the business every day. So, yes, the FDD is boring reading. There is data and figures and statistics and charts. All the things that might make your eyes glaze over. But look hard at that document. It is the key to learning just how good of an opportunity that franchise really is.