Franchising and the FDD – Before you can purchase a franchise, you will receive an approximately two-hundred-page document known as the Franchise Disclosure Document or FDD. It is composed of twenty-three sections called “items.” The Federal Trade Commission mandates that a franchisor must furnish this to their candidates at least fourteen days prior to the sale of a franchise. It is full of information about the history of the franchise, mutual obligations, and other data pertaining to the company you are interested in buying.
There are also a number of states that require franchisors to register their opportunity and that give franchise buyers certain legal rights. These states have franchise investment laws that require additional disclosure requirements. In essence, these states treat the sale of a franchise like the sale of a security.
The FDD is a marvelous document and is one of the key reasons why franchising has been so successful. You can achieve a level of transparency through the FDD that is not possible in other investments or in business opportunities. Contained within the FDD are information on legal issues that may have occurred, backgrounds of the corporate executives, financial representations, current franchise owners’ names and phone numbers, and the names of franchise owners who have left the system. There is a lot of juicy information here!
You cannot just call a franchisor and ask for the franchise’s FDD. You usually need to be a candidate that the franchisor has expressed an interest in by approving your application.
Compare the FDD to a pointillist painting, composed of thousands of small dots. Looking at it from afar, it is a harmonious and comprehensive subject. The point of this chapter is to help you look at the dots in the painting closely to understand how they all work together.
Oftentimes, if the Franchisor perceives you to be serious, they will send you an FDD immediately. My recommendation is to not read the FDD until you understand the business by research you have done and after talking with other franchisees.
I know that sounds counter-intuitive, but you will probably run away from the business if you read the FDD before you understand the business model and how it has run by others. It is scary. It is pretty one-sided (it was written by the franchisor’s lawyers after all). It is designed to not only protect the franchisor but to protect all the franchisees from a rogue franchisee and give the franchisor the power to maintain the integrity of the business model as well as the investment of all the franchisees. Reading the FDD will not teach you the business any more than it will help you understand the moral character of the franchisor or the business activities of your fellow franchisees. After all, what is the point of reading and understanding the FDD only to find that you don’t like the franchisor nor the franchisees in the system?
Key areas to focus in on initially are Items 5,6,7 and 19. Items 5-7 will lay out your initial franchise fee. Item 6-7 will walk you through your upfront and ongoing expenses to anticipate. Many, but not all FDDs will have an Item 19, Earnings Claims, which represent financial performance. This section includes the actual and projected average earnings of the franchise and how the figures are derived. It helps benchmark your performance goals and the performance of a typical owner. Some franchisors do not furnish earnings estimates or projections. The best source for this information is from franchisees already in operation. Of course, every individual wants to perform better than a typical franchise owner, but it is a good idea to start here with these numbers. Even if a company doesn’t have an Item 19 in their FDD, you can always ask a franchisor for their revenue and expense models as you get closer to making a purchase decision.
If you have further questions on how to derive the detailed information to make an educated decision on the franchise, speak to the franchise owner, many franchisees, and a franchise attorney. They all key contributors to learning about the business as well. I would also be happy to help walk you through my experiences in these regards.