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.
May 28, 2010 by Frank Goley, Business Consultant
In the meantime, if you want more information on Franchising, check out my article:
I hope you and your Family have a Great Memorial Day Weekend…Best, Frank
Posted in Business Franchise.
May 27, 2010 by Frank Goley, Business Consultant
A Franchise System can be a very effective way to open and operate a small business, especially for those without a lot of experience in operating and owning their own business. There are many advantages in using a Franchise System, such as, turn-key operations, marketing and business planning; large corporate support; lower learning curve; established accounting, cost control and management systems; brand identification; training programs; national and regional advertising; customer service programs; market trend responsiveness; supplier and vendor discounts; among others. However successful Franchise Systems are expensive. The fees / costs consist of a franchise fee, royalty fees and start-up costs. So it is very important to have a solid due diligence process in place to determine if a particular Franchise Opportunity is right for you, and whether the costs to establish and run the franchise match the effectiveness of the Franchiser’s Package Offering.
Types of Franchising Systems
Product / Service and Trademark Franchising
This is an arrangement which the franchisee is granted the right to sell a well recognized brand. Most franchisees concentrate on one franchiser’s product/ service line, identifying their business with the franchise. Examples include: Automobile Dealerships, Gas Stations, Soft Drink Bottlers, etc. The franchiser exercises little control over the franchisee’s business, with the product/ service integrity being the biggest concern of the franchiser.
Structure and Responsibilities
– Franchiser provides a Standardized Product
– Franchisee Pays Franchise Fees and Responsibilities include:
ü Control System
ü Operating System
ü Accounting System
ü Building, Equipment, Signage
Business Format Franchising
Franchisee is granted the right to use a turn-key marketing system, with substantial assistance and guidance from the franchiser. Types of franchises include Restaurants, Retail, Hotels, Business Services; Automotive Products, Parts and Services; Convenience Stores; Entertainment Centers and so on.
Structure and Responsibilities
– Franchiser provides:
ü Building Plans
ü Equipment & Signage
ü Marketing System
ü Business Plan
ü Operating System
ü Training Personnel
ü Accounting System
ü Control Systems
– Franchisee provides:
How to Determine if a Franchise Opportunity is Right for You
Franchise Analysis Checklist
Ø About The Franchise
ü Has your attorney approved the franchise contract?
ü What legal grey areas have been identified?
ü Will you have exclusive territory?
ü Does the franchiser work with any other franchise handling similar products and services?
ü What are the Franchise Contract termination penalties?
ü If you sell your franchise, will you be compensated for goodwill?
Ø The Franchiser
ü What is the franchiser’s number one focus?
ü How have franchisees in the past run into trouble? Difficulties?
ü What skills franchisees need most?
ü How are conflicts resolved?
ü Request the bios of Top Management. Do they have entrepreneurial backgrounds?
ü Do the franchiser’s earnings claims differ from their Franchiser Disclosure (FDD)?
ü Has the Franchiser executed detailed due diligence on your qualifications?
ü How many years has the Franchiser been operating?
ü Does the franchiser have a reputation among the franchisees, competitors and business world for honesty, integrity, accountability and fair dealing?
ü Has the franchiser shown you certified and audited financials on franchisees in your region and area which you can validate?
ü Does the franchiser provide Executive Management and Personnel Training Programs?
ü Does the franchiser provide any Capital or Credit?
ü What merchandising Programs and Training does the franchise offer?
ü Will the franchiser assist with site location?
ü Does the franchiser have adequate financing to implement its Franchisee Plan?
ü Does the Franchiser have a highly trained and experienced management team?
ü What can the Franchiser bring to the table which you can’t adeptly do yourself?
ü Has the franchiser complied with State Laws in the past? What State Laws are in place regarding Franchise Sales?
Ø The Franchisee
ü How much Equity Capital will you need to:
§ Purchase the Franchise?
§ Operate until Break-Even?
ü Where will you get the Equity Capital?
Note: Please see my Articles on Small Business Finance for extensive resources and information on obtaining business capital and commercial finance.
ü Are you prepared to give up some independence for the advantages offered by the Franchiser?
ü Do you believe you have the qualifications to succeed as a franchisee? What other Personnel resources can you provide?
ü Are you prepared to spend a majority of your business life with this franchiser?
Ø The Market
ü Does an adequate market exist in your area?
ü Will the market support the price level of the franchiser’s products and services?
ü What are the population demographic trends for your territory over the next 5 years?
ü What will be the demand for your product and service in 5 years?
ü What is the non-franchise and related franchise competition in your territory and region?
Examine Franchise Opportunities
v Determine which franchises are growing fastest.
v Research market growth possibilities.
v Consult Entrepreneur Magazine for its comprehensive Franchise 500 Listings.
v Utilize the U.S. Commerce Department’s Franchise Opportunity Handbook, which is published annually.
v Contact the International Franchise Association for assistance.
Determine What the Franchise Can Do for You
Typical Franchiser Services
ü Start-up help, to include market analysis, site location, financial advice; building and equipment design and purchase.
ü Successful Operational System.
ü Accounting and Cost Control System.
ü Monthly operating results support; performance standards; financial auditing; franchisee financial comparative analysis.
ü Financial Assistance: land, building, equipment, inventory and working capital.
ü Site purchase assistance.
ü Standardized Construction, Design and Signage.
ü Training Programs.
ü National and Regional Advertising Program.
ü Brand Recognition Promotion.
ü Customer Services Standards and Program.
ü Responsiveness to market changes.
ü Supplier discounting via large volume ordering.
Franchise Due Diligence
Examine more than one franchise and compare / contrast through a standardized checklist (see previous section). Investigate franchises in the same line of business.
Speak with Existing Franchisees
Ø Contact several franchise owners listed in the FDD, as well as, not referenced by the Franchiser to solicit their experiences.
Ø Seek out franchisees that have been in the business over 5 years.
Ø Talk with experienced franchisees about what to expect during the first year of operation- the typical success or failure period for a franchise.
Ø Ask franchisees to share their Business Plan with you. This gives you an inside track on the operational and planning expectations for a typical franchise, along with keys to success.
Ø Ask franchisees what the Franchiser does to justify all the fees charged.
Ø Determine how well prepared franchisees were when opening the franchise. Surprises? Franchiser weaknesses?
Ø How effective are the Marketing, Promotion, Branding and Advertising Programs? Do they bring the right customer to franchisees?
Ø Determine the real financial numbers. How much to open a franchise? How quickly a franchise started making money? Get the real story and compare it to the Franchiser’s disclosure to determine credibility.
Ø Do your research and homework prior to meeting with Franchisees so you don’t waste their time and you appear serious.
Ø Make a good, professional impression on franchisees as they often will report their impressions to the Franchiser.
Ø Understand where the franchisee is coming from: i.e. Someone close to your territory may give you faulty information if he feels competitively threatened. Or, a franchisee may overstate his/ her success.
Ø If allowed by the FDD, consider a Joint Venture with an experienced Franchisee. An 80/20 relationship can make a lot of sense to both the new and experienced franchisees in a proximate region or area.
Ø Try to spend an entire day with each Franchisee. This is the only way to get a true fell for the franchise and determine why the franchisee is successful (or conversely, why he/ she is blowing smoke). Build a relationship with franchisees, and you will be more apt to receive honest, diligent and detailed feedback.
Ø Ask franchisees if the franchiser encourages the franchisee to share feedback, ideas, successes, failures and whether these experiences get incorporated in the field.
Ø Is the franchisee happy with their life post franchise opening? Is the business enjoyable?
Ø For more ways to get a franchisee to open up to you, visit Entrepreneur.com
Seek Professional Advice
v Franchise Attorney and Accountant
v Franchising Consultant
v Business Consultant
v Finance Consultant
Understand your Legal and Ethical Rights
Ø The International Franchise Association serves Franchisers in more than 50 countries and has a code of Franchisers’ Ethics and Obligations to Franchisees.
ü Franchiser members pledge to comply with all laws and make complete, accurate, non-misleading disclosure statements and documents.
ü Franchiser members pledge to only accept franchisees that meet prescribed qualifications.
Ø Understand your rights if the Franchiser attempts to buy back the franchise.
Ø Issues to explore:
ü Captive Supplier Pricing
ü Inadequate Service
ü Slashing Support Services
ü City and State Laws & Regulations regarding Franchises
Posted in Business Franchise.