You always should show your franchise disclosure document (FDD) to a franchise and business attorney, but you also should pay specific attention to six key sections well. Your due diligence can make a huge difference in the success — or downfall — of your franchise.
While it sounds intimidating, the FDD isn’t a legally binding agreement. It’s a disclosure, and one that every franchisor has to provide to potential franchises at least 10-14 days, depending on the state, before any agreements are signed. It’s meant to protect everyone, especially the owner-to-be, by explaining everything necessary so that franchisees can make an informed investment.
As soon as the franchisor has received your application, you can request their FDD. It might be a hard copy or digital. Many franchisors have their FDD online and some are available through state registries and paid online sites, allowing you to research and compare potential companies on your own.
The FDD has 23 categories, called “Items,” as required by the Federal Trade Commission; they’re all important, but six rise to the top:
Litigation (Item 4)
If there’s any previous or current litigation against or by the company for the prior 10 years, it has to be revealed in this section. This might include fraud convictions, unfair/deceptive business practices, or franchise law violations. Clearly, this is important information to know!
If civil action has been taken on the franchisor’s behalf against a franchise owner, that will be listed here also. Some litigation with big companies is to be expected — but a lot could be a red flag.
Franchisor, Predecessor and Affiliates (Item 1)
The first category is critical. This gives you a summary of the franchised business, its model and information on any affiliated or related businesses. It’s also where you’ll get information on the industry’s competitors, which might make or break your decision to move forward.
Franchise Outlets (Item 20)
You’ll want to take a look at franchise owners, past and present. If you see a lot of franchisees who have left the system, that’s another warning sign. A large percentage don’t jump ship without good reason! Call them, question them and see if they’re unhappy with their experience. Every FDD is required to include the names and contact information for all current franchisees and those who have recently left the franchise system.
Fees (Items 5 AND 6)
All the fees that you have to pay to the franchisor will be outlined, including franchise fees and deposits necessary to claim ownership. Look seriously at all the ongoing fees such as royalties and advertising fees. You don’t want any surprises.
Financial Performance Representation (Item 19)
Not every franchisor provides a financial performance representation. But, when they do, the information gives you a glimpse into the potential earnings and averages of a franchisee. The figures here must be based on real and provable numbers and a franchisor is required to give you the substantiation to back up the numbers. You should look at these representations closely and call franchisees to verify their accuracy.
The FDD is a long and seemingly cumbersome document. But don’t let the FDD overwhelm you. It’s meant to serve you. Read it all, jot down any questions, and come prepared for your meeting with a franchise lawyer. This is a huge decision that can be rewarding if you’re diligent.
Call the Franchise & Business Law Group to schedule your free initial 30-minute consultation with an experienced franchise attorney, and make sure you study the FDD beforehand, and bring a copy with you.