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10 Things to Look for in a Restaurant FDD
Due diligence is essential to finding success with a franchise model.
Before you purchase a franchise, it’s your responsibility to research potential franchisors to determine the best company in which to invest. You can do the bulk of this research by looking at companies’ Franchise Disclosure Documents (FDD).
The Federal Trade Commission legally requires all franchisors to give potential franchisees an FDD at least 14 days before the franchise sale. The document includes 23 detailed sections explaining the franchisor history, franchisor responsibilities to the franchisee, costs to the franchisee and franchisee obligations under the franchise agreement. It’s designed to help prospective franchisees weigh the costs and benefits of purchasing a specific franchise.
While each item in the FDD is important, we’ve listed the top 10 things to look for, specifically in a restaurant FDD.
1. The most important piece to look at is item 19: financial performance representations. This section allows you to see full numbers, average revenue, average cost for operating and more. Prospective franchisees can more easily see how much money they’ll make by purchasing the franchise. For example, a few million in revenue sounds great, but if the costs are higher than expected, it’s no longer a good deal.
2. Next is item seven: total initial investment. In a restaurant brand, your investment cost will be the biggest expenditure. Section seven of the FDD includes a table that outlines the entire estimated cost of starting the franchise to the franchisee, including the initial franchise fee outlined in item five and additional costs paid to third parties. Additional costs include rent, utilities, equipment, inventory, signs, an initial advertising fee, training and licenses. The definition of the initial investment period varies by franchisor, but typically it’s at least three months.
3. Item three: litigation. Section three of the FDD lists lawsuits involving the franchisor, parent company, predecessor, affiliates and the executives. Any pending, current or recently resolved litigations will be listed. If something is listed, it is something you should probe, as it could be a deal-breaker.
4. Along with item seven, items five and six, Initial fees and other fees, are important when weighing the costs. Look above royalties to see if there is a general marketing fund, POS fees, technology or any other fees associated. Make sure you understand how much money you’ll have to put into the franchise relative to the money you’ll get out of it. One way to be sure is to review these costs with an accountant.
5. Item 12: Territory. Section 12 of the FDD states whether the franchisor will offer the franchisee the exclusive right to open a franchise in a given area. It also describes the circumstances in which the franchisor would approve a franchise relocation and any plans the franchisor has to open a competing franchise system. Territory rights are important because they protect the franchisee from competition. For example, if a restaurant franchise opens on the corner of 1st and Main, an exclusive territory right could prohibit the franchisor from opening another across the street.
6. Item 21: Financial statements. Section 21 of the FDD includes the franchisor’s audited financial statements from the previous three fiscal years. This tells you the health of the organization and helps you understand if they are capitalized and profitable enough to support the franchise system. This is most critical in smaller, newer restaurant brands.
7. Item 20: Outlets and franchisee information. This section includes five tables showing the number of franchised outlets and other company-owned locations in the past three years. This is important to look at if you’re considering a smaller, startup restaurant franchise because if it’s smaller, the franchisor might not have as much experience. For larger brands, you can see if the company is growing or shrinking. Have they closed 20 locations in the last year, or has growth been steady?
8. Again, if you’re considering a smaller brand, make sure you look at item two: business experience. This will show you if the franchisor has experience in the industry. If they don’t, now is the time to probe questions on the franchisor’s experience with the franchise system and operating restaurants.
9. Item 17: Renewal, termination, transfers and dispute resolution. Section 17 of the FDD includes a table summarizing the franchise agreement, including terms about renewal, extension and transfers of the agreement. It explains if a renewal means the franchise agreement terms will be extended, or if the terms are subject to change at the time of renewal. Make sure you understand the terms. Is there criteria for having to renew in X amount of years? What’s the transfer process if you decide to sell it?
10. Finally, it’s important to check out item nine: franchisee obligations. This section tells you what you’re responsible for and what you’ll need to do, if anything (participate in training, conferences, staff training, etc.).
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