A How-to Guide for Reading a Franchise Disclosure Document
Jul 11, 2018
By Kevin King, Chief Development Officer
The Franchise Disclosure Document (FDD) is one of the most important documents you will need to review carefully when deciding to buy a franchise. It provides the answers to 22 questions about the franchisor and franchise system that are required by the Federal Trade Commission.
While many potential franchisees immediately jump to Item 19 to find out the financial performance of individual franchise units, it’s important to start at the beginning of the FDD. It’s a wealth of information about the history of the brand and the people running the company, any pending litigation, fees for and obligations of franchisees, and more.
Items You Definitely Don’t Want to Gloss Over
There are some sections of the FDD that potential franchisees should pay particularly close attention to. They include:
- Items 5 and 6 – Initial and Other fees: Information on the franchise fee and other initial fees is found in these sections. Other fees may include recurring fees and payments, such as operating and marketing fees. Any ranges of fees and the factors that determine them will be in these sections, too.
- Item 7 – Initial Investment: This section is extremely important. It covers the expenditures required by the franchisee to get a franchise up and running. Some of the questions this section answers are: How much is this franchise going to cost me? Where do I spend the money? Who do I pay it to?
- Item 9 – Franchisee’s Obligations: This portion of the FDD helps the franchisee understand what is required of him or her. While a franchisee does have a lot of autonomy, they are obligated by the franchise agreement to follow some rules and procedures vital to maintaining the brand.
However, having said that, each item needs to be reviewed thoroughly. For example, some other items to be considered are:
- Item 3 – Litigation: This is where you’ll find present and past civil and criminal litigation, if any exists. You may be asking yourself if the franchisor and their management team have been involved with anything sketchy in the past. This section will help answer that.
- Item 18 – Public Figures: This section informs you who the public figures are, if used, and how much the person is paid. Are you comfortable with the brand using this person for brand awareness?
The FDD will alert you to any red flags about the franchisor, if they exist. For example, if the litigation section is pages and pages long, you should wonder who you are really dealing with. Also, make sure the fees match up with what you were told initially by the franchisor’s development or sales team.
Item 21 – Financial Statements will provide you with a look at the financial health of the organization. You should see a red flag if the company is not financially sound.
Think Before You Read
Carefully reading the FDD is a critical step in an entrepreneur’s due diligence process. But, the first step in the process – how you feel about the brand after the interaction you’ve experienced with the brand’s franchise development team – should determine whether you read the FDD or not.
Before you spend any time reading a FDD, ask yourself, “Do I like these people? Do I like what they do?” I think reading the FDD is very important after that step.
Don’t Be Scared of the FDD
The FDD is a large and often intimidating document that is hundreds of pages long. A franchise candidate might want an attorney to review it with him or her; it just depends on the candidate’s financial and business acumen.
It’s incumbent upon the franchisee to know what they’re getting into. Yet, as important as the FDD is, franchisee candidates may consider just glossing over it because it is a big and daunting document. And, often, people don’t understand the purpose and intent of the FDD anyway.
By not thoroughly reading a FDD, franchisee candidates face many potential pitfalls—especially misaligned expectations. For example, the franchisee candidate may be surprised to find out the true cost of buying and running a franchise. They may be unaware of the various fees and obligations if they did not read Items 5, 6, 7 and 9 FDD closely enough. They may be in for a rude awakening to eventually learn a franchise is not legitimate – it doesn’t have any money, it lacks background and experience, or the sales team was not honest. All these things can happen, and you’ll miss them if you do not read the FDD.