Franchise Disclosure Document: What to Look for When Reviewing an FDD
by Jonathan Thiessen, Chief Development Officer, Home Franchise Concepts
Congratulations on reaching the level of your due diligence into franchising, where you can review the most critical document in the process, the Franchise Disclosure Document (FDD). Over my 32-year career in franchising, I’ve often heard this document referred to as “the bucket of cold water” because it’s easy to let the magnitude of all the information in it douse the excitement you may have had about launching your franchise. I want to offer a few suggestions about approaching your review of the FDD and where to focus your time on your initial pass.
Before reading the first page, understand that any good Franchisor will have an FDD that “favors” the Franchisor. The reason is that it’s the job of the Franchisor to defend the system and the brand so that it can flourish for you and your fellow franchisees. The best franchisees in any network are the ones that embrace and follow the system. A lot of the language in the FDD focuses on how a franchisor can protect those franchisees and your brand from the occasional rogue player who may try to damage the brand by coloring outside of the lines.
The disclosure document also includes a sample Franchise Agreement that will be identical to the one you will sign if you are awarded a franchise. All of the information in the Franchise Agreement is the same as in the first 23 Items of the FDD, with just a lot of legalese thrown in to keep the lawyers happy. It is essential to review the Franchise Agreement or even have a franchise lawyer review it for you before signing it, but your first run-through is spent best understanding the Items in the FDD.
The 23 Items in the FDD are uniform by design in any franchisor’s FDD. It allows for standardization and easy comparison between different brands. While every Item is essential in its own right, there are a few sections that I would suggest you pay particular attention to in your initial review.
- Item 2: This is where you get to understand the Leadership in the organization. I would encourage you to learn as much as possible about their current roles and backgrounds as they steer the ship. Perhaps connect with them on LinkedIn or ask your Advisor about their Meet The Team Day involvement.
- Item 3 and 4: This describes the organization’s litigation and bankruptcy history. It’s rare in this day and age to see a company except of any litigation history (unless they are very new), but if there is pervasive litigation, you need to ask why and what it’s all about. A good Franchisor is transparent and should be prepared to speak to anything in this section.
- Item 5-6: This section is critical as it details all of the fees, both at the onset and ongoing so that you are clear on what will be required when you join and throughout the term of the agreement. Our system has no “hidden” fees, so you can feel confident that what you see is what you’ll pay at most.
- Item 7: This is one of the most important sections of the agreement because it should clearly state the amount of capital you need to get started. There is typically a range depending on the number of units you are opening and whether things are being financed or paid for upfront. The biggest mistake that Franchisors and Franchisees both make is getting into a franchise undercapitalized. I don’t care how great your airplane is; if your runway is too short to get off the ground, it’s just an expensive car with wings.
- Item 12: This section deals with the territory, and it is vital to know how they work, what protections you are provided, and what’s available for you to select in your market of choice.
- Item 19: Many regard this as the most crucial Item in the FDD because it speaks to the potential earnings of the business. You should understand the source and scope of the information to determine if it is a comprehensive sample source, just from company-owned units or a mix of the two. The Franchisor is not allowed to discuss any potential earnings that the business can make outside of what is presented in Item 19, so any further insight you may want will need to come from validation calls with the franchisees. Many Franchisors will provide these numbers in Tiers so that you can see the differences between high and lower-performing franchisees. Between Items 5,6,7 and 19, you should be able to build a base-level proforma to understand if the numbers make sense for the kind of return you would expect on your investment.
- Item 20: This shows the organization’s growth year-over-year and where they anticipate growth going forward. If there are trends in the growth cycle, it’s important to ask your Advisor why.
As mentioned previously, there are no unimportant Items in the FDD for you to review, however, as someone who has reviewed hundreds of these documents over the years, I always spend most of my time constructing my list of questions from these Items in particular. Enjoy your research!