Rochelle Spandorf, a partner at Davis Wright Tremaine LLP, gives her top tips for franchisees reviewing their first FDD.
Reading a franchise disclosure document, or FDD, likely isn’t anyone’s idea of a good time, but it is important. The FDD contains valuable information that will help a prospective franchisee decide whether they want to, in fact, enter into a franchise agreement with a brand.
Enter franchise attorney Rochelle Spandorf, a partner at Davis Wright Tremaine LLP. While most of the FDD-related work Spandorf does is on behalf of franchisors actually writing the document, she also represents franchisees, multi-unit ones in particular, in their due diligence by reviewing FDDs with them. Spandorf shared her insights with 1851 Franchise on which items in an FDD a prospective franchisee should pay especially close attention to.
“The FDD is technically the entire book with all the exhibits,” she said. “The book begins with a cover page and ends with a receipt but inside are all the exhibits and the first part of this book you’ve got the 22 disclosure items. Item 23 is the receipt that goes at the end.”
With that said, Spandorf believes that prospective franchisees should pay especially close attention to Item 3, Item 7, Item 19, Item 20 and Item 21. By doing so, she said, they will better understand a lot of the specifics of the agreement, including its duration.
“I’ve learned over the years that there are a lot of misconceptions franchisees have about what they’re buying,” she said. “The franchise is sold as, ‘own your own business,’ but in fact, one of the biggest surprises for them is that a franchise is a license, often for a finite period of years. It’s not forever. There will be an initial term and there may be a renewal term, but very few franchise programs have an unlimited term.”
Prospective franchisees should review Item 3 in the FDD, Spandorf said, to see if there are any patterns in litigation involving the franchisor because, “If there’s a pattern of fraud claims, that’s a big red flag.”
Prospective franchisees should also make sure to carefully review Item 7 in the FDD, estimated initial investment. Spandorf said it is extremely important to have a detailed discussion with the franchisor to learn what is behind the numbers in Item 7 because if they are underestimated, franchisees will be at a disadvantage before their doors even open, Spandorf said.
Spandorf noted the famed Item 19, financial performance representations, deserves close attention so that prospective franchisees truly understand whether there are any caveats to the financial figures the franchisor has included in an effort to make the opportunity seem more favorable.
As far as Item 20 is concerned, Spandorf said the FDD “can only provide so much information,” so accessing existing franchisees for validation purposes is key.
“It doesn’t provide context,” she continued. “It doesn’t give you feedback on how effective the training or marketing programs are, or on how much support franchisees really got before and after they opened. That’s what Item 20 is for.”
Prospective franchisees should also pay close to attention to Item 21, which contains the financial statements. The information in Item 21 will depend on how long the brand has been franchising.
If the brand is newer to franchising, “the reality is that these financial statements won’t tell a prospective franchisee very much about the franchisor,” Spandorf said, adding that “If you’re buying a franchise in a more mature franchise system, Item 21 financial statements should show a steady growth in revenue over the years.”
Revenue growth, she noted, is an indication that franchisees are doing well and the system is growing and ends up being more significant than the number of franchises units sold.
“You want to see a growth in revenue more than you want to see growth in the number of franchises because just selling franchises that never open is not a good sign,” she said.
Keeping Spandorf’s advice in mind sets prospective franchisees up for success as they take on the task of digesting all of the information contained within an FDD.