Don't Skip These Items When Reviewing Franchise Disclosure Documents

Entrepreneurs that are seriously considering buying a franchise will encounter a dense-yet-informative document at the pivotal point of the franchise purchasing process called the Franchise Disclosure Document (FDD). The FDD is created by the franchisor and provides candidates with an extensive look at the inner workings of the business to help them make their decision.

Comprised of 23 sections called Items, The FDD contains tons of relevant information that prospective franchisees must thoroughly digest before being able to make a truly informed decision. This is easier said than done for most because FDDs typically run several hundred pages long, but there is a lot at risk for a prospective franchisee if they don’t properly review an FDD.  

“The FDD is the playbook by which a candidate will be expected to run their business, and without a full understanding of the expectations of the franchisor from the onset, the prospective franchisee is setting themselves up for a troubled relationship,” said Jonathan Thiessen, Chief Development Officer for Home Franchise Concepts. “Not only do they need to understand each facet of the franchise agreement they are entering into, but they also need to be willing to comply with each as determined by the franchisor.”

To help franchise candidates understand where relevant information lies within the pages of an FDD, 1851 consulted Thiessen and Ted Milburn, Director of U.S. Franchise Development for Wienerschnitzel, who provided their insights into the Items readers shouldn’t glaze over when reviewing the document.

Items that require a critical eye

Understandably, the first place most people turn to when reviewing an FDD are the sections that cover the financial aspects of the business.

“Items 5 [initial fees], 6 [other fees], 7 [estimated initial investment] and 19 [financial performance representations] are the most critical items for Home Franchise Concepts when evaluating the financial fit of the prospective franchisee,” Thiessen said. “The candidate’s understanding of the capital necessary to start the operation and see it through until profitability is essential to the success of the franchised business.”

Also recognizing the importance of a franchisee’s financial obligations, Milburn called out Item 7 as a section of the FDD franchisees should have a deep understanding of, while also pointing out another section of importance: Item 15.

“Item 15, or Obligation to Participate in Business, allows us to understand a prospect’s ability to meet financial and personal investment requirements – so [this is] obviously crucial,” Milburn said.

Items that contain the most detail

Again referencing Item 19, Thiessen called the section “the most complex and detailed portion of the FDD.” It should be, he argued, “so that the prospective franchisee has transparency in evaluating the viability of the business model from a financial standpoint.”

FDDs are designed to help franchise candidates uncover all relevant information to help them make an informed investment, so naturally, financial performance representations should be thorough. Also requiring ample detail, Milburn noted, is the section of the FDD dedicated to outlining the franchisor-franchisee relationship.

“I’d say Item 17, the Franchise Relationship, is the most detailed,” Milburn said. “This Item essentially references the franchise agreement, with a provision or summary for each topic.  Since this is often the most common topic of conversation throughout the process overall, it is in the candidate’s best interest to read and understand completely.”

Items that are often overlooked (but shouldn’t be)

“I think Item 20 [current franchisee information] is often not given the attention it deserves,” Thiessen said. “While franchise development executives are often quick to talk about the rate at which the brand is signing new franchisees, the rate of store openings, and the percentage of businesses that remain open, it is also vital to know: Does the franchisor have a backlog of units that need to open before yours? Are people exiting the brand at a high rate? Why?” he said. “These are important considerations to evaluate as a candidate looks for the right fit”.

For Milburn, the FDD Item franchise candidates too frequently gloss over is Item 3, which covers litigation.

“Unfortunately, this part of the FDD is often overlooked,” he said. “It is important for a candidate to understand the general nature and volume of legal claims against a franchisor. The fewer the claims, the better the sign. I’d encourage a candidate to ask franchise representatives about litigation basics,” he added.

As far as their best pieces of advice for prospective franchise owners when reviewing an FDD, both stressed the importance of asking questions about anything and everything they may not understand.

“If there is something in the agreement that is difficult to understand, don’t glaze over it in the hopes that it will just work itself out,” Thiessen said. “If your conversations with franchise development executives don’t sync-up with everything in the FDD, be sure to address it in the form of an amendment. Much can and will change over the course of 10 years, but your franchise agreement won’t.”

By making sure to carefully review these FDD Items, franchisees will have a better understanding of the franchise concept they’re considering, allowing them to make the best decision possible for themselves.

“FDDs detail the governing terms and conditions of a potential business opportunity and long-term relationship,” Milburn added. “Read with an open mind, take notes, ask questions. I encourage a candidate to read through the entire FDD and ask questions throughout the entire learning process, and then again in-person during their discovery day. This process best prepares a candidate to cross the finish line."