What to Look for in an FDD When Buying a Franchise
Do you know what items to look for in a franchise disclosure document (FDD)?
If you are buying a franchise, you may already know about the FDD and the importance of this document in helping you to assess the risks of your franchise purchase. However, with 23 disclosure items, it is difficult to absorb this document in its entirety and to then determine which disclosures are most important.
If you are concerned about what to look for in an FDD, we have done the heavy lifting for you and found the five disclosure items we believe are the most important.
Five Important FDD Items
The FDD is a disclosure statement that outlines 23 items about a franchisor’s business and each party’s expectations under a prospective franchise agreement. A franchisor must disclose this document to a franchisee at least 14 days before they enter into a franchise agreement and a franchisee makes any payment towards this agreement.
It is important for a franchisee to understand the terms and risks of each disclosure item—these five in particular:
1. Estimated Costs (Item 7)
This disclosure gives franchisees an idea of what the initial costs will be to open a franchise. Franchisees should ensure that they have the capital to start the business and assess whether the estimated profits will be worth the initial investment.
2. Territory (Item 12)
A franchisee should also understand the territory terms of their franchise agreement. This disclosure outlines whether the franchise will be in an exclusive territory, blocking similar businesses from operating within a certain radius which may help to boost franchise sales.
The territory terms will also outline whether your sales are limited to a specific territory or whether you can operate outside of your territory. This information can also help you to estimate the sales and profit margins for your business.
3. Franchisor’s Obligations (Item 11)
You should also understand what the franchisor is required to do in helping you get the business started. Some standard franchisor obligations are:
- Franchise site selection: Will the franchisor locate, purchase, or lease the franchise site?
- Equipment, inventory and provisions: Will the franchisor provide the essential supplies needed to operate the business?
- Employee selection and development: Will the franchisor hire and train the franchise employees?
Before entering the franchise agreement, ensure that you completely understand these obligations.
4. Financial Statements (Item 21)
The franchisor should disclose their audited financial statements for the past three years. These statements will give you a look at their financial strength and whether their business has been fiscally successful or will continue on that wavelength in the future. Make sure you review these statements with an experienced accountant.
5. Renewal, Termination, Transfer, and Dispute Resolution (Item 17)
Finally, make sure you understand your rights to:
- Renew the franchise agreement
- Terminate the agreement
- Transfer the agreement to a new franchisee
- Resolve disputes via arbitration or mediation
Understanding these rights can help you to assess your restrictions following the termination of the agreement or if you have a dispute with the franchisor.
If you need help understanding the important terms in an FDD or have questions about starting a franchise, contact us for assistance!