Understanding How To Efficiently Read Franchise Disclosure Documents

Buying a franchise is one of the biggest financial decisions a person can make. Whether you are a first-time owner-operator or a seasoned multi-unit absentee owner, investing a great deal of money and time into a concept can be scary. Once you find one or two franchises that check off all of your boxes, it’s time to dive even deeper—into the franchise disclosure document.

Franchisors are required by law to provide these documents, with the purpose of supplying prospective franchisees with a complete, in-depth rundown of the franchisor, the franchise system and all other relevant information. 

With 23 items of thorough and valuable information to get through, it is important to read each FDD efficiently and with a careful eye. 

Know Where to Look First

Each of the 23 items serves to provide information necessary for insightful and informed decision-making to the prospective franchisee—but certain items can give a quicker and more streamlined understanding of the franchise opportunity. 

For example, some experts recommend flipping right to the end and starting with Item 21, which represents the financial audit of a franchisor’s financial statement reporting obligations. Item 21 gives prospective franchisees a look back at the last three years of a franchisor’s financial performance and how the assets and cash flow of the franchisor correspond to the number of franchised units it projects to sell or support. 

“This is an area you can look at to see how stable the company is,” said franchise attorney Lee Plave, a partner at PlaveKoch. “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 the brand has the resources to support the system that you are buying into or not.”

Pay close attention to the profit-and-loss statement and balance sheet—if the franchisor has limited resources but a large number of franchisees, thus earning most of their money from franchise sales, that could spell trouble.

Know Where To Find the Bottom Line

For most franchisees, it comes down to one key question: How much money am I going to make? That said, there are several components that are involved in determining the bottom line. Item 19, which provides information about the financial performance of the franchise, is usually the go-to section for financial expectations.

Item 19 is not required and each franchisor can include or withhold as much information as they see fit. Some brands, such as Penn Station, have adopted a completely transparent Item 19, in which the return on investment is based completely on in-store sales, as opposed to relying on discounts or third-party delivery.

“Instead of having to construct the economics of a franchise opportunity, you can identify and verify through shorter due diligence calls because you’re not starting from scratch,” said Lane Fisher, a franchise attorney at Fisher Zucker. “It allows franchisors to provide information about highly efficient units, such as those located in malls, kiosks, strip malls and differently sized restaurants, which allows you to know which footprints are the most productive.”

While Item 19 covers how much a franchisee can potentially make, Items 5 through 7 answer how much the franchisee is expected to spend. Item 5 outlines the initial franchise fee; Item 6 outlines ongoing fees such as technology and marketing fees; and Item 7 gives a solid estimate of the total cost of opening a franchise. 

Getting to Know the History

An effective reading strategy is to group related items together to create a holistic picture of different categories. For example, if a candidate is most concerned about the history of the brand and its financial track record, they should focus on items 1 through 4.

Item 1 outlines the founding of the franchise, Item 2 provides information about the founder and management team, Item 3 covers any litigation from the past decade and Item 4 discloses bankruptcies. 

In this section, be on the look-out for limited work experience, inflated resumes and of course litigation.

“The litigation history of a brand can be very telling about a franchise system—but it’s not always a bad thing,” said Amy Cheng, founding partner of Cheng Cohen LLC. “That’s why it’s important for prospective franchisees to have a full understanding of the type of litigation that a brand has been engaged in.” 

Know Where to Find the Support

If support is your primary concern, consider paying especially close attention to items 8, 11, 14 and 17. The bulk of the FDD is dedicated to providing franchisees with an overview of a franchisor’s support system. 

Item 8 discusses supply and operations, while Item 11 details training procedures and Item 14 outlines copyright and intellectual property information. Finally, Item 17 deals with logistical issues such as transfer options, grounds for termination and dispute resolution. 

“A prospective franchisee should have a clear understanding of what is to be expected when it comes to training, ongoing support and advertising,” said Eric Martin, VP of Franchise Development for home services franchises Mosquito Hunters and Lawn Doctor. “Item 11 will provide a detailed overview of what is covered in the initial training program as well as ongoing support for both training and marketing. If there’s a section you are going to read more than once, this is it.”

While FDDs will always be time-consuming, knowing how each item relates to which questions can result in much more efficient and manageable reading.

Don’t Be Scared to Ask for Help

First of all, no matter how confident a candidate is in their ability to understand a brand’s FDD, it is always helpful to have a second set of eyes. Whether it be a franchise attorney or franchising expert, bringing on the consult of seasoned FDD readers can prove to be extremely beneficial in the long run. 

Franchise legal experts are able to poke holes and highlight any potential issues with a better understanding of what is important and significant in relation to your decision. A second opinion can make a prospect feel confident that a brand is a solid organization, which will help them decide to franchise with the brand in the future.

Franchise disclosure documents are the best, and in some cases, the only place to find red flags and potentially unflattering information about the brand

 that could affect franchisees, as well as selling points that may draw them to the opportunity. Careful reading, second opinions and an efficient understanding of each item can ensure that franchisee candidates don’t miss key pieces of information when making their decision.