Franchise disclosure documents are similar from one franchisor to another because the FTC requires them to be in a very specific format. All FDDs are required to include these 23 sections.
Item 1 & 2 History, Parents, Affiliates and Business Experience: Describes the type of business, the competition, the history of the franchise company, and the business biographies of the directors, officers, and key managers. The franchisor is your partner in building your own business, so you want to be sure they’re up to the task.
Item 3 & 4 Litigation and Bankruptcy (if any): Any lawsuits between the franchisor and franchisees, or franchisor and regulators. NOTE: many highly successful franchisors do have some lawsuits – in this day and age it is hard to avoid litigation entirely. But you do want to watch for any undue litigation or areas of concern.
Item 5 Initial Fees: Details about the initial franchise fee for starting a business can be found in item 5. Any discounts for military veterans, first responders, minorities and financing for the franchise fee is described here. If offered, details about the area development fee and muli-unit franchise fee are provided here.
Item 6 Other Fees: This section include details about the royalty fee, marketing fund contribution, local marketing requirements, technology fee, transfer fee, renewal fee and any other fees. Details about the amount, due date and any other remarks are provided in item 6.
Item 7 Estimated Initial Investment: The estimated initial investment detailing the breakdown of all expenses need to get the business operations up and brand recognition established. This will also include any real estate requirements for the franchise.
Item 8 Restrictions on Sources of Products & Services: Any restraints on the sale of products and services, and also on their sources. (e.g., you must source ingredients from a specific supplier)
Item 9 Obligations: The franchisee’s obligations under the agreement (e.g., days you must be open) in order to run a successful business.
Item 10 Financing: This section explains any financing options for the start up costs available through the franchisor directly.
Item 11 Franchisor’s Obligations: What the franchisor must do for ongoing support for the long term. This includes corporate-provided support such as training, operations manual, social media advertising, marketing plans, and computer systems.
Item 12 Territory: Where you will be allowed to operate or market or open your business
Item 13 & 14 Trademarks and Patents: The legally protected intellectual property of the franchisor
Item 15 Obligations to Participate in the Actual Operation of the Franchise Business: Some franchise models require franchisees to be owner-operators. Others can allow you to hire managers to run things while you keep your full-time job. Make sure your obligations line up with your vision. If you don’t want to be on site every day, don’t buy a franchise that requires you to run day-to-day operations.
Item 16 Restrictions on What the Franchisee May Sell: Being part of a franchise system does provide a proven system, but it also means you will be required to follow certain parameters. For example – you wouldn’t be allowed to offer tuna sandwiches in your McDonald’s franchise. This keeps other franchisees from damaging your reputation by selling off-brand items.
Item 17 Renewal, Termination, and Transfer: How your relationship with the franchisor will continue or end.
Item 18 Public Figures: Who is affiliated with the franchise in their marketing, such as spokespeople.
Item 19 Financial Performance Representations (previously known as “earnings claims”): If the franchisor makes any earnings claim about averages, customer base or cash flow, it will be in this section. Only about 15% of all franchisors make any earnings claims – where they disclose how much money their current franchisees are making. That’s not a red flag; it’s just a choice they made.
Item 20 List of Outlets and Franchisee Information: Names, addresses, telephone numbers of all franchisees in the system and also the last known address of all franchisees who left in the last year, for whatever reason. With this information, you have the ability to talk to anyone in the system – top performers, those who may be struggling, new franchisees and those who have been in the system for many years.
Item 21 Audited Financial Statements of the Franchisor.
Item 22 Copies of Any Contracts: The Franchise Agreement, leases, and any other documents a franchisee may be asked to sign.
Item 23 Receipt of the Disclosure: To be signed by you, so the franchisor has evidence for the regulators that they have complied with the disclosure regulation.
The FTC believes this document includes everything you need to make a decision. We agree it is vital to review this document carefully before signing a franchise agreement, but we also believe it provides little information that you will find useful in the early stages of your investigation.
If you spend more than 2-3 hours reviewing one FDD, you are probably getting more detailed than you need to in the early stages. You will want to spend a majority of the due diligence process talking to existing franchisees, understanding how to grow your business. We encourage you to research the pros and cons of franchises and if you like what you are hearing, then you can proceed.
The franchise disclosure document is supposed to help you, not confuse you. Call us to turn those pages of jargon into insights that help you make a good decision.
