Understanding the Franchise Disclosure Document (FDD)

June 1, 2010 by Frank Goley, Business Consultant

The Franchise Disclosure Document is one of the most important tools to utilize when assessing a franchise opportunity. However, it shouldn’t be used exclusively for a franchise assessment. See my previous blog on Finding the Right Franchise Opportunity for more tips on analyzing a franchise system.

The Franchise Disclosure Document or FDD has replaced the Federal Trade Commission’s Uniform Franchise Offering Circular (UFOC) and has differences in three key areas:

v  Information in Tabular Format for easy comparisons between different Franchisers.

v  Post ’79 changes in the Franchise Business, such as different hardware and software requirements.

v  Earnings Claims by Franchisers, called Financial Performance Representations, are more informative and valuable to prospective franchisees.

The FDD is organized in a format to provide fairly easy comparisons between various franchises.  It has 23 sections, and we recommend reading through the entire FDD, making notes of important areas to explore and assigning responsibilities for certain key sections to your Legal, Accounting & Consulting Experts.  Using Mr. Elgin’s approach, we lay out the different sections of the FDD, highlighting important areas and information for the Franchisee’s Due Diligence Process.  The FDD by itself doesn’t have all the information necessary to make an informed decision on the viability of a franchise opportunity; however, if used in conjunction with our suggested Franchise Checklist and other suggested areas, such as, Examining Franchise Opportunities, Determining What the Franchise can do for you, Franchise Due Diligence Tips, Utilizing the Experience of Existing Franchisees, seeking Professional Advice and Understanding your Legal & Ethical Rights, the FDD is certainly a valuable due diligence tool.

FDD Items #1-4:  History

Item 1:  Franchiser business history, including predecessors and affiliates.  It is the key overview of the franchiser.

Item 2:  Background data on key officers, directors and employees, including corporate management.  Summarizes their work experience of the past five years, along with experience serving as officers/ directors of other companies.  This is key information as it will show how much experience Franchiser Corporate has in the business, which translates often into franchisee success.

Items 3 and 4:  Past or current litigation or bankruptcy on the part of the franchiser and its key personnel.  Have your Legal Advisor review.

FDD Items #5-7:  Fees and Costs

Item 5:  All initial fees charged to begin the business.

Item 6:  Other fees charged in subsequent operation, such as royalty, advertising, renewal and transfer fees.

Item 7:  Breakdown of every component of the franchisee’s initial investment to include an advertising allowance and operating capital reserves.  Provides ranges of potential costs, which you will need to firm up with existing franchisees and through your due diligence research.  Determining the most accurate projection of costs for your territory/ location and circumstances is key.

FDD Items #9,11 and 15:  Contractual Obligations

Item 9:  Franchisee obligations, including business responsibilities and legal obligations.  Carefully review this section with your Franchise Attorney and Consultant.

Item 11:  Franchisor contractual obligations.  This is very important as it outlines what you’ll receive in exchange for the franchise fees charged, including pre-opening and on-going assistance, training programs, franchise systems and advertising programs.  This is a good section to review your Franchise and Business Consultants and works well in conjunction with our Suggested Franchise Due Diligence Checklist.

Item 15:  Franchise personal obligations and expectations in the franchise operation. 

FDD Item #12:  Territory

Protected or Exclusive territory terms if offered. Give this very careful review.

FDD Item #17:  Exit Strategies and Dispute Resolution

§  Restrictions on Renewal, Termination or Transfer of the Franchise Agreement.

§  Dispute resolution methods, including Binding Arbitration.

§  Should review this section with your Franchise Attorney.

FDD Item #19:  Financial Performance

§  Franchiser’s representation of unit financial performance.

§  This section will not answer the franchisee’s question about how much money he or she can make.  To answer this question, utilize your Due Diligence Checklist, the Marketing Section, to determine what your prospective market will translate into financial projections.  Working closely with existing Franchisees in your area will help firm up your projections.

§  This item will provide you initial clues to apply in determining what your area can produce in terms of prospective franchise profits.

§  The disclosure contains three types of information:

·         Revenue/ Expense Data

·         Assumptions used in the Financials

·         Disclaimers about the usefulness of the information

It is important to review the assumptions behind the franchiser’s financials in order to accurately understand, as well as, apply the financial information given.  For instance, the data may be too dated to be useful for your particular analysis and projections.

It is very important to review this information with your Accountant and utilize the experience of your Franchise and Business Consultants in constructing an accurate financial picture for your particular franchise opportunity.§  When speaking with existing franchisees, be sure to verify both the franchiser’s financial data and your own market research and financial projections to determine realistic expectations of market potential and financial results.

FDD Item #20:  Existing Unit Data

§  Information about the number and locations of existing franchises.

§  This includes information from units that have closed or transferred ownership.

§  This item is valuable for your market research.

FDD Items #21 and 22:  Financial Statements and Contracts

Item 21:  The Franchiser’s audited financials for the previous three years. An indication of the Franchiser’s financial strength and stability. Review with your Accountant.

Item 22:  Franchisee Contracts, including the Franchise Agreement and other contracts covering personal guarantees, real estate assignments, advertising, co-op rules and conditions, territorial development schedule, etc.

Other Important Rules, Restrictions and Information

Items 8,10,13,14,16,18 and 23

§  Where you can purchase supplies.

§  What products and services a franchisee can offer.

§  Personal participation obligations.

§  Financing Programs

§  Public Figures or Celebrities associated with the Franchiser.

§  Status of trademarks patents and copyrights.

§  State specific rules, regulations and information.

Be sure to review these items with your Business Consultant, Franchise Consultant, Franchise Attorney and Finance Consultant.

Posted in Business Franchise.

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