Recommendations include a balanced understanding of costs and potential returns, the guidance of counsel or a consultant, plus a strong cup of coffee.
Let’s say you’re a prospective franchisee.
You’ve completed your due diligence, gone to discovery day, talked over goals and plans with your franchise consultant…as the saying goes, all that remains is to “cross the t’s and dot the i’s.” It’s time to read the franchise disclosure document, or FDD, and officially become a franchisee.
The FDD is comprised of 23 items, including the franchise agreement, or contract that solidifies the business relationship between franchisor and franchisee. FDDs “are designed for the benefit of the candidate, to disclose the franchise opportunity so that they can make an informed decision,” explained No Limit Agency’s Chief Development Strategist Sean Fitzgerald. “[The purpose behind the FDD design] is to standardize it. This allows readers to compare one franchise to another, regardless of investment level, industry, etc.,” said Fitzgerald.
Informative though they are, FDDs are long and text-rich. And this is where the neckties begin to feel tight.
“For many people, their first encounter with an FDD can be an incredibly overwhelming experience,” said Matt Sole, President of Anago of the Bay Area, a commercial cleaning service franchise. “There is nothing like opening up a 200-plus page document filled with lots of numbers and legal jargon to cause panic. At Anago, we understand that is the typical reaction and since the FDD is such a critical document in explaining various aspects of the franchise opportunity, we spend ample time with potential franchisees to walk them through some of the core aspects of the document,” Sole said.
Mike McCoy is the VP of Franchise Sales for Auntie Anne’s, the soft-baked pretzel franchise. He agreed with Sole, but also felt that the opportunity for franchisor and franchisee to parse an FDD together contributed to a stronger partnership.
“I have found that most franchise candidates appreciate the amount of information that is included in the document,” McCoy said. “We will meet with them and review various sections of the FDD to make sure that they understand what it contains and have the opportunity to ask us questions. By the time we finish meeting with a candidate, they have a very good understanding of the FDD and what they can expect both in terms of the investment, as well as the support, assistance, and training they receive from us as the franchisor.”
McCoy still recommended that candidates new to franchising work with a business advisor, such as a franchise attorney or consultant, so that they know they have ready access to guidance should they hit any snags.
As for which elements of the document tend to attract candidate attention more often than not, Sole and McCoy agreed: risk and returns.
“In our experience, many of our potential franchisees have been around to other similar franchisors,” explained Sole. “They are often most interested in the initial fees with the different programs we offer as well as what the ongoing fees may look like.”
“Candidates are always interested in understanding the potential financial returns, so Item 19 [of the FDD] is very helpful to them,” McCoy said.
Additionally, candidates are understandably primarily focused on what it’s like to work in a franchise system.
“For many, the franchise model provides huge benefits to get started in a proven system and reduce the risk on their part, however, they also need to feel comfortable they can operate within the restrictions of the brand and reach their financial goals,” said Sole.
Because of the myriad legal, operational and financial details contained within the document, both Sole and McCoy emphasize that it’s critical to closely read the entire document.
“[Candidates] need to understand their obligations as a franchisee related to ongoing fees, use of approved products, operational compliance, etc.,” Sole explained.
He added that candidates also need to think beyond initial fees and consider the working capital they’ll need while building the profitability of a new business location, and he advised that they partner with a lawyer or accountant to review document details.
When discussion turned to the somewhat infamous Item 19, or “Financial Performance Representations,” both McCoy and Sole had similar recommendations.
“I believe Item 19 is a huge factor in the consideration of a franchise,” McCoy explained. “The more complete the information is in Item 19, the more confidence a franchisee can have that they understand the business model and whether their expectations on ROI are reasonable. We are very clear with [candidates] that the information in Item 19 is not a guarantee of their performance, but it is reflective of a large number of actual locations and can help them when they work on their own financial modeling and business plan.”
“Item 19 can easily be misused or misinterpreted if there is not sufficient data or information included,” McCoy continued. “Many Item 19 disclosures only report top-line sales numbers, but do not shed much light on the costs. In my opinion, it is more useful to the franchisee to include data on both the revenue and costs involved with the business. You need to understand both in order to make a reasonable judgment.”
Sole pointed out that many candidates go the route of the franchise so they can mitigate risk and get straight into a proven model that can help them achieve their financial goals.
“Because of that, Item 19 can be a valuable resource to confirm the franchise being evaluated meets their individual goals and show that the brand continues to improve and grow, which I think is probably one of the most import factors in considering a franchise opportunity,” Sole said.
After reading an FDD, franchise candidates should be aware of the investment level of the venture, total cost, how long it takes to get started, what level of support is made available from the franchisor—both in the beginning and as the business grows, advised Sole and McCoy.
Ultimately, franchise opportunities are about partnership: “We look for candidates who are not only financially qualified, but who we believe will take all the tools that we provide and utilize them to maximize their success. We are there at every step to help them, but we can’t do the work for them, so understanding the relationship and getting a good feel for the fit of the candidate is crucial to the long-term success of the franchisee and the brand,” said McCoy.
Still reading after having decided you’re going to go for it and tackle your first FDD? Sole and McCoy have a few recommendations.
“Block out ample time to do a detailed read of the FDD and note any areas you want further clarification on so there is nothing left unclear by the time you sign on,” Sole said. “Let your accountant or franchise lawyer know ahead of time you would like their help reviewing the document so they can be prepared to turn it around to you quicker and you’re not waiting on their feedback to move forward.”
“And,” Sole added, “always allow time after the initial meeting to revisit the FDD and discuss any questions that may arise once [you] dive deeper into the document.”
“Grab a strong cup of coffee and jot down any questions that you may want to ask the franchisor,” said McCoy. “The document is meant to fully disclose the obligations of both parties, but should not take the place of a meeting with the franchisor. Contact other franchisees to see how they feel about the brand and ask them any questions about their experience and the operation of their business,” he advised.
If the time has come for you to dive in, take a breath and relax. With the right mindset and counsel, franchise candidates are well-positioned to master the FDD and hit the ground running on the day of their Grand Opening.