What is an FDD?

With so many franchise options out there, it’s hard to find the one that’s right for you. Once you have found “the one” it’s an exciting, yet stressful time filled with phone calls, paperwork and research. Arguably, the most important step in this process will begin when you are handed the Franchise Disclosure Document (FDD).

The FDD is a document that outlines the history of the business, fees, rules and restrictions, all the franchisees in a system, turnover rates, renewal terms and other aspects of a particular franchise. The FDD encompass 23 Items with additional Exhibits following the Items. To ensure that franchises are giving prospective franchisees the proper amount of information needed to make an educated decision, the Federal Trade Commission (FTC) mandates that the FDD be provided to the prospective franchisee no later than 14 days before any binding documents are signed.

The FDD is typically over one hundred pages and is a fairly daunting task. Sean Fitzgerald, Chief Development Strategist at No Limit Agency* says not to worry. “If you’ve never seen an FDD before it's intimidating, but it's designed for the candidate. It breaks down the information uniformly, so all franchises are all the same. It has a great relevant information for the candidates and is in their best interest and they should take time to digest the information.”

In order to assist you as your review your FDD, 1851 Franchise has listed each Item and outlined what to look for and any potential red flags to review. Below is a breakdown of what to expect in each section.

Sections 1 - 4 will breakdown the history of the franchisor. This is where you look for any potential red flags in the franchisors history such as failure to pay royalties, trademark infringement or non-compliance.

Section 1 -- The Franchisor, Affiliates, Parent Company and Predecessors

In this section you will learn how long the franchisor has been in business and their complete history. You will learn about any specific laws that pertain to the industry and permits that may need to be acquired.

According to Fitzgerald, “This Item is important in order to fully understand who truly owns the franchise.” Fitzgerald continued, “This will reveal if the franchise is owned by a parent company, which is an important consideration for prospective franchisees.”

Section 2 -- Business Experience and Identity of Leadership

This section will identify the key executives in the franchise and learn what role they play in the company.

Section 3 -- Litigation

Here you will learn if any executives within the franchise have pending or past lawsuits. It is important to note the nature of the complaint and how it was resolved. Felonies listed include: fraud, violations of franchise law, unfair or deceptive practices/misrepresentation and settled civil actions.

Section 4 -- Bankruptcy

Legal matters are also noted in this section. You will see any bankruptcy filings within the past decade by the franchise or any key executive. Bankruptcies are not necessarily bad. It is important to look into them to understand why they were filed and ensure they are not part of a bigger issue within the franchise. Bankruptcy information can be helpful in assessing the franchisor's financial stability and whether the company is capable of delivering the support services it promises.

Sections 5-7 will break down of franchise costs including franchise fees, ongoing costs and estimated individual investment. These sections are crucial in helping you understand the total cost associated with becoming a franchise owner.

Section 5 -- Initial Franchise Fee

Here you will learn the investment necessary to purchase a franchise. Many of these costs must be covered before the doors of your business can open. It will lay out everything including franchise fees, non-refundable fees, deposits, inventory fees, equipment fees, signage fees and royalty fees.

Section 6 -- Other Fees and Expenses

This section helps you to understand the ongoing expected costs associated with owning a franchise including: training, advertising, marketing and software. Deadlines for these fees will also be disclosed.

Section 7 -- Initial Investment (Estimated)

By now you understand that the initial franchise fee is only a small percentage of the costs associated with purchasing a franchise. This section will combine the total of the fees outlined above. The total is the dollar amount you’ll be expected to invest if you were to choose to be a part of the company.

Section 8 -- Restrictions on Sources of Products or Services

In order to maintain uniformity, this section will outline where franchisees are able to purchase goods and services. This helps to maintain consistency and quality across locations.

Section 9 -- Franchisee Obligations

This section is a table of contents for the FDD which lays out franchisee obligations and where you can find the content in the FDD.

Section 10 -- Financing

Here the franchisor will explain if they offer any financing programs. These can range from loans, to installment plans, to leasing arrangements. It is important to note that financing from a franchise is just like financing from a bank. If a franchisee defaults, the franchise agreement can be terminated.

Section 11 -- Franchisor Obligations

In item 11, the FDD breaks down the assistance and training new franchisee are provided to help them get started. This can include information on training, advertising, software and advertising support and opening assistance.

Section 12 -- Territory

The territory in which you will be allowed to operate and where you are able to solicit customers is outlined here. You will learn whether each franchise has an assigned, protected territory or not. You can likely modify your territory when you renew your contract.

Section 13 -- Trademarks

This section lists the trademarks, copyrights, patents and proprietary information you will gain the rights to under the franchise agreement.

Section 14 -- Patents, Copyrights, Proprietary Information

Similar to section 13, this section lays out the patents and copyrights you gain access to. It is important to review this section in order to better understand the patents and patent restrictions for your potential franchise.

Section 15 -- Obligation to Participate in the Actual Operation of the Franchised Business

Here you will learn the expectations of being a franchise owner. This can vary from franchise to franchise. Some expect you to manage the day-to-day operations, while others are fine with you hiring outside assistance. It also will outline whether or not the franchisee can participate in any other business ventures while under contract with the franchisor.

Section 16 -- Restrictions on What the Franchisee Must Sell

As stated in Section 8, franchisors limit what you can sell to maintain consistency across all locations. These restrictions should all be expected, but it’s important to review for any unexpected restrictions.

Section 17 -- Renewal, Termination, Transfer and Dispute Resolution

This Item details the procedure for renewing your franchise or exiting a franchise at the end of your agreement. The procedure for dispute resolution will also be outlined here.

Section 18 -- Public Figures

Should the franchise use public figures in their advertising, the details of their relationship would be listed here. 

Section 19 -- Financial Performance Representations

“The FDD is standardized throughout the whole document; the Item 19, however, is purely unique for each franchise,” Fitzgerald said. “You’re no longer comparing apples-to-apples. Item 19 is a great tool to gauge a brand’s track record and where it will be heading in the future.”

This is arguably the most important section of the FDD, however, franchisors are not required to disclose information about potential income or sales. If they do, the law requires they have a reasonable basis for their claims. It is up to you to examine this section very closely and look for the following: figures from corporate stores, average sales and earnings, gross sales, geographic difference and number of years the franchise has been in operation.

Section 20 -- List of Franchise Outlets

This is a spreadsheet that contains all the franchises that have opened, closed or transferred in the past three years and the names of the franchise owners. Ideally, you see consistent growth. If you don’t, you want to look into why there wasn't growth over a certain time period by contacting franchise owners to better understand any trends.

Section 21 -- Financial Statements

Here you will find important information about the company’s financial status, including audited financial statements. This can showcase the overall health of the business, ideally showing steady growth and income from royalty payments as opposed to franchise sales. 

Section 22 -- Contracts

These are the contracts you will be required to sign if you choose to open a franchise. Contracts include the franchise agreement along with the following: confidentiality agreements, leases, finance documents, purchase agreements, service agreements, software agreements, bank draft authorizations and promissory notes. Be sure to review these documents with a franchise lawyer.

Section 23 -- Receipt

You must read and review the FDD at least 14 days prior to signing a franchise agreement. This section acknowledges that you received the FDD. Both you and the franchisor should sign this receipt.

Congratulations -- you made through the FDD review process! It’s not easy, but now you are fully equipped to make an educated decision on your future with a franchise.