What Prospective Franchisees Need to Know About Item 4 of the FDD: Bankruptcy

In order to determine which franchising opportunity is best for you, you’re going to need to become familiar with the Franchise Disclosure Document, or FDD.

While FDDs—and their 23 items—seem overwhelming at first glance given that they’re hundreds of pages long and filled with technical terms, it’s well worth it to take the time to read through them fully alongside an attorney or franchising expert. At the end of the day, the information contained in an FDD explains the ins and outs of a brand’s business ownership opportunity, ultimately allowing candidates to determine if a concept is the right fit for them. And one of the items in a brand’s FDD that prospective franchisees don’t want to overlook is Item 4, which highlights a brand’s history with bankruptcy.

“There are a lot of reasons that franchisors could file for bankruptcy. From financing to prior management, it’s important to know why a brand had to take that step,” said Amy Cheng, founding partner of Cheng Cohen LLC. “But filing for bankruptcy isn’t a make or break deal when it comes to a brand’s long-term success. I’ve worked with franchisors who have been able to bounce back after filing bankruptcy and others that haven’t been as successful. That’s why it’s important to understand the circumstances surrounding it.”

Beyond looking into the reasons behind an entire brand filing for bankruptcy, it’s also critical for prospective franchisees to thoroughly examine Item 4 of a brand’s FDD to see if there are any members of a concept’s leadership team who have personally filed for bankruptcy. And according to Cheng, it’s equally important to keep the context behind the filing in mind in this case too.

“In addition to paying attention to whether or not a brand has filed for bankruptcy, you also want to check and see if there are any officers or executives from a brand that have filed personally. If there’s one member of the leadership team who has filed for bankruptcy over the past 10 years, there’s no need for it to automatically be a black dot on the entire franchise concept. But if there are multiple C-level executives who have filed for bankruptcy in a brand’s recent history, you’re going to want to take the time to understand why,” said Cohen.

Filing for bankruptcy does not automatically lead to a brand’s demise. In fact, its purpose is to give a brand time to reorganize its business so that it can once again restore its operations and get to a positive place. That’s why it’s recommended for candidates to take a look surrounding the current financial performance and health of a brand—if a brand has filed for bankruptcy, prospective franchisees should be on the lookout for a plan to ensure that it doesn’t happen again. But if a brand has filed for bankruptcy and has not been able to bounce back in a timely manner, it can raise a red flag for future owners.

While Item 4 of a brand’s FDD can provide great background information on a brand’s financial state, it’s important to realize that there are other disclosed items that take a deeper look into a brand’s performance. According to Steve Beagelman, founder and CEO of SMB Franchise Advisors*, those are the items that candidates really want to hone in on when going through the pages of a concept’s FDD.

“The first items of an FDD are there to help candidates understand the ins and outs of the company. From litigation to bankruptcies, having a general overview of a brand’s position is essential for prospective owners when determining the brand that’s right for them,” said Beagelman. “But this information is just the tip of the iceberg. After candidates have the opportunity to understand the gist of a brand’s business ownership opportunity, they need to dive into the specifics. That’s where the next items come into play.”