How To Read a Franchise Disclosure Document

Whether you are an experienced franchisee or first-time candidate, reading a franchise disclosure document can be overwhelming. Made up of 23 sections called “Items” and consisting of hundreds of pages, FDDs provide prospective franchise buyers with a detailed analysis of the business ownership opportunity they are considering.

1851 has written many articles that can help first-time readers break down each section. While each item is important, some are more essential than others. Here's what to look for in an FDD.

The All-Important Item 19

While it is important to read the whole document, most people start by skipping to the end for this one reason: Item 19. This section is the bottom line of financial performance metrics for the franchise. 

“Item 19 is arguably the most important section of the FDD, however, franchisors are not required to disclose information about potential income or sales,” said Rob Flannagan, President of Wag N' Wash. “If they do, the law requires they have a reasonable basis for their claims. It is up to candidates to examine this section very closely.”

Flanagan suggested looking for the highs and lows in figures from corporate stores, gross sales, average sales and earnings, as well as noting geographic differences between locations and the number of years the franchise has been in operation.

Other Key Areas To Consider

John Gotaskie, partner at Fox Rothschild LLP, works with franchise brands of all sizes and is no stranger to the FDD. He advises franchisees to read through the entire document but to focus on a few key areas that could make or break their decision to buy.

“Item 1 gives an overview of who the franchisor is — who is the parent company and its affiliates,” Gotaskie told 1851 Franchise. “But don’t take that information at face value. Do some Googling. Do some research. Find out all you can about the company. Does it have a good track record? If there were problems in the past, were they related to things beyond control?” 

Item 2 covers business experience, and this is another area in which prospective franchisees really need to do their homework. For example, brand executives may be selling themselves as more accomplished than they are. 

Items 3 and 4 cover litigation and bankruptcy, respectively, and Gotaskie noted that, “Every system is going to have litigation, it’s a fact of life. It’s more important to figure out whether a brand has a lot of litigation, and what the character of it is. Is it disgruntled people who joined the system 30 years ago and are unhappy now that there's more structure and less autonomy? Or does it suggest fundamental differences in the system?”

Prospective franchisees should also closely review Item 7, which is a summary of start-up costs. Gotaskie suggested that prospects look at financial statements and get a copy of the franchise agreement and compare it, line by line, to what the FDD says. 

Why You May Need An Attorney

Items 13 and 14 relate to trademarks, another thorny legal area as franchisees can get caught up in third-party lawsuits if the assets aren’t protected. “If you want to take the step of buying a franchise, it’s important to know how well their assets are protected,” said Gotaskie. “Does the brand license a trademark from someone else? In most franchise operations, [the trademark] is one of the most valuable things you’re going to be licensing. You want to make sure that is rock solid, so you don’t get dragged into a third-party lawsuit.” 

While the FDD contains a lot of information, the language used should not be overly technical. If prospective franchisees have questions after reading through the FDD very carefully, they shouldn’t be scared to ask an expert, franchise attorney or the franchisor for help.

Contracts Besides The FDD

“Outside of the franchise agreement itself, there are a lot of other contracts that franchisees have to sign, like a POS operator, product supply company, or non-compete agreements,” Gotaskie said. “Compare those contracts with the FDD itself to make sure it's in line. You might have to sign a POS operator, or make a personal guarantee in regard to financial issues. Or maybe you and your spouse and senior managers have to sign non-compete agreements. All of those are disclosed in the FDD, so make sure you understand those forms and that they match with what is outlined in the FDD.”

Conclusion

“The document is written to protect the franchisee and the franchisor, but it in no way can fully encompass the depth of the franchise partnership,” said Flannagan. “We think of it as a marriage agreement — no one builds their marriage off of the legal paperwork, right? There is no way an FDD can predict what is going to happen in a sector, it simply details the guidelines and guard rails to protect the relationship.”

Now, with these insider tips, candidates should be better equipped to crack open the franchise disclosure document and start the process of determining whether the franchise is a match.