Franchise attorney Lee Plave shares his insights on FDDs and what prospective franchisees should be aware of.
Making the entrepreneurial decision to buy a franchise is scary enough; you are investing your life savings and a tremendous amount of time into a concept with the hopes that it will flourish. Once you ultimately narrow your search down to one or two concepts that check off all of your boxes, it’s time to dive into their franchise disclosure documents—and if you’ve never seen one before, they can make things even scarier.
FDDs are legal documents that are presented to prospective franchise buyers that cover details about the franchisor, initial fees, initial investment, financing options and more. 1851 Franchise connected with franchise attorney Lee Plave, a partner at PlaveKoch, to pull together a beginner’s guide to FDDs.
“Before a franchisee even begins looking at the FDD, I suggest they bring on competent legal counsel to walk them through the document,” said Plave. “Failure to do so will end up costing them in the long run.”
Once a franchisee officially has legal counsel on board, Plave suggested starting with Item 21. This item outlines the franchisor’s financial statements and includes audited statements from the past three years.
“This is an area you can look at to see how stable the company is,” said Plave. “Are you buying into a company that has a solid track record? Or is it a company that has low cash flow? Item 21 tells you if they have the resources to support the system that you are buying into or not.”
Starting with Item 21 will give you a good idea of the longevity of the franchisor and if they are standing on strong legs.
Next, Plave suggested looking at Items 5 and 6, the sections that lay out initial fees and other fees. Initial fees show the reader the factors that make up the franchise fee, and the other fees section provides a description of all other recurring fees or payments that the franchisee is responsible for.
“A franchisee should be looking at these Items to make sure that they are logically explained,” said Plave. “Beyond that, think about whether these are sustainable and practical based on what you can handle. These Items will give you tangible knowledge and allow you to be practicable and reasonable in your expectations.”
As his final area of the FDD that requires the most attention, Plave highlighted Item 7. This is the section that lays out the initial investment in a table format and includes all of the expenditures required of the franchisee in order to enter the franchise system.
“When you read the table in Item 7 as a prospective franchisee, make sure you do not ignore the footnotes that go with it, as this is where you can find specific details,” said Plave. “The franchisor uses this space to give their best guess, which is the most they can do. It’s up to the franchisee to take this information and do their own deep dive.”
Plave went on to explain that reading through an FDD is an art, not a science. There typically aren’t clear-cut items that will point to the exact longevity and success of a business. Because of this, it is important for franchisees that are unfamiliar with the documents to bring someone onto their team who has looked at hundreds of these in the past.
“More franchisees than not fail to get the kind of guidance they need to truly understand whether or not the franchise they are buying has strength,” said Plave. “The last thing you want to do is have this come back to bite you in the long run.