How to review item 20

When exploring a franchise opportunity, the two most important source documents to consider are the Franchise Disclosure Document (FDD) and franchise agreement. Reviewing these documents, in addition to interviewing current and former franchisees in the system, are best practices to follow when doing an evaluation of the brand.

Item 20 in the FDD can tell you much about the franchisor and its performance. Unfortunately, this Item doesn’t usually receive the scrutiny it deserves.

There are five tables in an Item 20 and each one represents specific information. Make sure you are well-educated on each of the tables and their purpose.

Table 1: This table presents the number of franchised and company-owned outlets and the net change over a three-year period. It also shows the number of outlets at the start of each year and the end of each year, along with the net change for each year. Check out the trends over the years, such as the increase in number of company-owned locations as opposed to franchisee-owned. Also look at how quickly the brand is growing year after year.

Table 2: Table 2 shows the number of transfers from franchisees by state for a three-year period. More established brands can show an increase in transfers when existing franchisees want to get out and exit the system. High transfer rates are not always a negative sign but could be a potential red flag to explore.

Table 3: The third table shows you the number of outlets at the start of each year for a three-year period, as well as the number opened, non-renewed, reacquired by franchisor, terminated and ceasing operations for other reasons. It then tells you the number of outlets at the end of the year. This table can show you negative trends. For instance, a large number of terminations and ceased operations can signal a bad franchise program. When franchise terminations and ceased operations exceed 5 percent of total franchisee locations, a red flag has been planted.

Table 4: Again, over a three-year period, the status of company-owned outlets is shown. Has there been a large increase in company-owned outlets? If so, the brand could be experiencing a decline in their franchise program. A decrease in company-owned outlets usually signifies the franchisor reselling company-owned locations.

Table 5: This table can be confusing. The table represents the “projected” new franchise outlets for the latest year. The projection of new franchise and company-owned outlets is broken down by state. In many cases, franchisors might project new outlets without significant research. The most important entry in this table is Franchise Agreements Signed but not Opened (SBNO). If the number is huge here you might have a franchisor more focused on selling new franchises than helping to grow and develop the system that already exists.