How To Build a Franchise Disclosure Document

If a company is interested in selling a franchise, the Franchise Disclosure Document (FDD) is perhaps the most important aspect to understand. This document, which is regulated by the Federal Trade Commission (FTC) and is required for the sale of a franchise, details the brand’s operations, fees, rules, turnover rates, renewal terms and more. This will be the main document that prospective franchise owners use to analyze the opportunity during their due diligence process.

1851 spoke to industry experts for advice on how first-time franchisors can build their FDD and convince more franchisee candidates to sign on the dotted line.

What Is an FDD?

The FDD includes 23 specific “Items” covering the brand’s performance history, leadership, bankruptcy or litigation rules, ongoing fees and expenses, financing terms, territory availability and more. Since the document includes more than 200 pages of heavy business jargon, many first-time franchisors will enlist outside help to ensure that everything is in order.

“Prospective franchisors will often work with a legal team and accounting team to properly outline their FDD,” said FranNet Vice Chairman and Principal Blair Nicol, CFE. “The legal team will work directly with the franchisor to help them establish best practices and get all of their spreadsheets, balance sheets and documents in a row.”

How To Start Building an FDD

Once a company decides to franchise a business, there are several resources it needs to bring into the FDD building process. To start, brands should have a business plan, operations manual and Franchise Agreement already drafted up. These documents also require the help of expert consultants and lawyers.

“The Franchise Agreement should be written up before the FDD so franchisors can include those contact and initial investment terms,” said Lane Fisher, lawyer partner at Fisher Zucker law firm. “Around that time, franchisors should also be working with somebody to help create an operations manual and training procedures, which will be included in the FDD. Some people will reach out to us without any preparation, and others come in with a very clear definition on what they want. While it is not required to work with a third-party organization when creating an FDD, it is very important to have experienced experts walking you through the process if you are new to it.” 

The most important aspect to bring into the process, Fisher said, is a proven business model. “The easiest path to creating an FDD is by utilizing the success of an established flagship location,” he said. “This will help first-time franchisors show unit-level profitability, transparency, scalability and customer loyalty. Franchisees will be studying the metrics of the business as much as possible and using the FDD as a primary tool when ramping up their business, so it is important to have those established best practices and documents in place.”

How To Make the FDD  as Strong as Possible

There are many ways emerging franchisors can utilize the FDD to make themselves look good and advertise the opportunity. In this way, the FDD can be more than just a legal disclaimer — it can be a sales tool as well. 

“In drafting an FDD, a lot of the info comes from the financial team, but it is important they collaborate with the sales team to emphasize the same message,” said Fisher. “The differentiators that make your concept stand out need to be communicated to the lawyers creating the FDD. If brands can get their messaging right in the FDD, it becomes a major part of the value proposition.”

In order to successfully balance the brand messaging and legal compliance needs within the FDD, Fisher notes franchisors really need a mentor to help them understand the most important sections and how they should be laid out.

For example, in FDDs, Item 19 provides potential franchisees with information about how much money they can make, the company’s earnings, costs and other factors that could have an impact on future finances. When someone is looking to buy a franchise, these are often the questions that are at the top of mind. Although the information is not mandatory, without a solid Item 19, franchisors are limited to what they can say about the financial performance of a business.

How To Avoid Common Mistakes When Building an FDD

Creating an FDD is a delicate process, which is why Fisher notes there are many mistakes that may arise. “Nobody but a lawyer should write an FDD — there are several issues that can come up when drafting the document, and lawyers have the resources and knowledge to get it done on time and give you more time to sell franchise licenses,” he said. 

For one, Fisher notes many franchisors decide something is negative about their business model or history, but sometimes those details can be legally required or even beneficial to include. Other franchisors may be looking to just copy another brand’s FDD, which can be risky, Fisher said. On the other hand, they want a document that isn’t going to stand out like a sore thumb and will blend in with the other FDDs prospects are seeing.

“In the franchise disclosure document, there are usually two things that are broken: the financial performance representation doesn’t include enough transparency or the numbers simply aren’t good enough — putting lipstick on a pig, as they say,” said Fisher. 

Less-than-ideal financial performance is an issue many franchisors may be dealing with this year following the COVID-19 crisis. “Brands need to work with professionals who can help them show as much recovery as possible in the FDD and help them understand where they fit in the COVID-19 continuum,” Fisher said. “This knowledge will be essential as franchisors create their 2021 FDD.”

Once the document is written and sent to a prospective franchisee, franchisors must give them two weeks to review the document before it can be signed. After sending a potential franchisee an FDD, brands should stay in contact and keep communication open to ensure leads don’t slip through the cracks.

The FDD is a crucial first step in franchising a business, so first-time franchisors should make sure to enlist the help of a professional and take every step necessary to ensure the document will promote healthy franchise growth.