Charles Internicola of the Internicola Law Firm shares what FDD Items can’t be overlooked and provides insight into the best ways to avoid confusion when reading these lengthy documents.
Pursuing business ownership as an entrepreneur isn’t an easy feat, even when backed by the support that’s inherent through franchising. Before a franchise agreement is ever signed, there’s a lot of hard work that goes into determining what franchise opportunity is best suited for each individual entrepreneur, and there’s no shortage of qualifications that prospective franchisees need to meet in order to be considered franchise candidates.
One of the most important pieces of this discovery puzzle is reading through and comparing FDDs, or Franchise Disclosure Documents. For first-time franchisees, these documents can be overwhelming — FDDs run hundreds of pages long and are filled with both legal and franchising jargon that can be confusing. That’s why 1851 Franchise reached out to Charles Internicola, the franchise attorney behind The Internicola Law Firm, to cut through the noise and break down what franchisees need to know before tackling their first FDD.
When it comes to his top piece of advice for first-time franchise candidates looking at an FDD for the first time, Internicola keeps it simple, saying, “Understand that the FDD is a legal disclosure document that has been prepared by the franchisor. For the most part, the information contained in the FDD is not verified and while the information and disclosures contained in the FDD are critical to the franchise review process, it's only one of many information tools that franchisee candidates should be evaluating.”
While going through that evaluation process, Internicola stresses that while every part of an FDD is important — including potential omissions that an experienced franchise attorney may notice — there are three items in FDDs that shouldn’t be overlooked. The first of these is Item 3, which covers litigation.
“If the franchisor discloses significant litigation with its franchisees, you'll need to evaluate the litigation carefully,” Internicola said. “As franchise systems grow, litigation, many times, becomes inevitable. But if Item 3 discloses a troubling pattern of franchisee litigation, you need to take notice.”
Internicola’s next can’t-miss Item is Item 6, which walks through other fees that may incur. He notes, “Item 6 includes a table summarizing the ongoing fees that you will be paying the franchisor. These fees are important to evaluate as they will impact the economics and profitability of your franchised business.”
Along those same lines, the third Item that Internicola stresses is Item 19. This Item is often cited as one of the most important in FDDs because it includes a brand’s financial performance representations.
“Franchisors cannot disclose financial information or financial performance history unless it’s disclosed in Item 19,” said Internicola. “If a franchisor does not disclose information in Item 19, you need to ask them, ‘why not?’ If they do, then you need to carefully review that information.”
In addition to these key FDD Items, Internicola recommends that aspiring franchisees also pay close attention to anything that may confuse them or raise questions. And when it comes to the Item in an FDD that most often confuses candidates or is the cause of the most questions, there’s one that Internicola immediately points to: Item 12.
“There are significant regulations and requirements that franchisors must abide by when describing the nature and type of territory protection that the franchisee will be granted. Franchisees benefit from territory protection, i.e., where the franchisor agrees to provide an exclusive or protected territory to each franchisee, and within Item 12, franchisors are required to disclose the type of territory protection granted to its franchisees,” Internicola explained. “Since there are many exceptions and carve-outs to territory protections typically granted, many times franchisee candidates experience confusion when reviewing Item 12.”
As franchise candidates become more comfortable with FDDs and work with experts in the field to understand their ins and outs, it’s important for them to compare what’s listed across brands’ FDDs in order to ensure that they move forward with the right business ownership opportunity for them.
“At the most basic level, you should compare the unit economics, i.e., compare the fees between each franchisor and their Item 19,” Internicola said. “At a deeper level, your franchise lawyer should be able to assess the quality of the FDD and whether or not one brand has omitted information that should have been disclosed to you.