What Is An FDD and Why Is It Important?
Franchising and The Franchise Disclosure Document
One of the most informational, stressful and yet sleep inducing documents you will run into during a franchise investigation is the Franchise Disclosure Document. What is this Franchise Disclosure Document you hear so much about, what does it mean and more importantly why do you need one?
The easiest way to look at intimidating information is to 1. Break it down and 2. Have some fun. The Franchising Disclosure Document (hereinafter referred to as “FDD”) - you might as well get your toe dipped into the water of some legal jargon and I would like to save my fingers from the typing.
The FDD is separated into 23 Sections or Items:
Item 1. The Franchisor and any Parents, Predecessors, and Affiliates
Item 2. Business Experience
Item 3. Litigation
Item 4. Bankruptcy
Item 5. Initial Fees
Item 6. Other Fees
Item 7. Estimated Initial Investment
Item 8. Restrictions on Sources of Products and Services
Item 9. Franchisee's Obligations
Item 10. Financing
Item 11. Franchisor's Assistance, Advertising, Computer Systems, and Training
Item 12. Territory
Item 13. Trademarks
Item 14. Patents, Copyrights, and Proprietary Information
Item 15. Obligation to Participate in the Actual Operation of the Franchise Business
Item 16. Restrictions on What the Franchisee May Sell
Item 17. Renewal, Termination, Transfer, and Dispute Resolution
Item 18. Public Figures
Item 19. Financial Performance Representations
Item 20. Outlets and Franchisee Information
Item 21. Financial Statements
Item 22. Contracts
Item 23. Receipts
The reason for this is to simplify the information along with the ability to compare different franchise concepts into the closest apples to apples parallel you can create. Whether you are investigating a well heeled 40+ year veteran franchise or brand spanking new concept - every franchise has an FDD. Why? It’s not to scare you or to put you to sleep at night, it is there to protect you.
Want a little franchise history lesson? The FDD was previously referred to as the UFOC (keeping up with the acronyms - Uniform Franchise Offering Circular). The UFOC became mandatory July 1, 2008, as this was part of the Federal Trade Commissions amendment of it’s 1978 Franchise Rule. The Federal Trade Commission of our US Government oversees franchising guidelines. This rule in 1978 was put into place to protect anyone looking into purchasing a franchise from sordid franchisor systems. Most notably in the section of returns the business could claim they had earned. Being in this industry for over a decade I have heard the term FDD - Franchise Due Diligence. Since this FDD is not what someone actually signs in contractual form it does make up a very crucial part of the investigation process. Even though there are legal terms and verbiage written in the FDD, it is actually a layman’s document of the actual Franchise Agreement.
Every year each franchise system registered with the FTC is required to renew the document with updated information and figures. A 2018 FDD will show you how much it will be to invest into they system (Item 7) this year and financial returns of locations form 2017 (see below for more on this). As business grow they develop and this needs to be in written format & updated. This way a franchisor cannot show you their stellar year - from 2003 only. Most potential franchisees do not notice this updating, unless you are investigating a franchise around the March - May time frame. This is when franchise systems ‘go dark’ as they register their FDD within each state. They cannot sell you a franchise or give you the current FDD during this process. For most states this is a mere hiccup in a weeks time. The franchisor files the updated and now current FDD to the state, they put it on file and carry on as usual. For 13 of our states it becomes an ordeal. The franchisor files it with the state, they have a designated state personnel read through the document to then deem if they will either file it or come back with more questions, clarifications etc. This can be to new or old franchisor systems. This can also take from 3 weeks to 5 months depending on the state. There are two states that are famous for taking their sweet time and if you live in one, you know who you are. Our condolences.
This can make it difficult to give potential franchisees the FDD during this March - May time frame. Typically a franchisor will give the FDD near the beginning of an investigation. This way you have plenty of time to review, re-read and gather questions. If the franchisor does not provide it you can request the FDD, so long as the franchisor has shown positive response to your initial application and you’re currently in an investigation. Per the amended Rule, franchisors must provide the FDD to candidates “at least 14 calendar days before the prospective franchisee signs a binding agreement with, or makes any payment to , the franchisor or an affiliate in connection with the proposed franchise sale.” The 14 days starts the day after the delivery of the document, which they can send you in printed or electronic form. This is where Item 23 also comes into play. They will ask you to sign the receipt page. This is no way binds you to any agreement. You are signing and dating receipt of the document only.
The FDD holds importance so that any potential franchisee can get clarity of the full picture of the business. This holds great importance, as you will learn the good, the bad and the in-between. Learning all of this information will give you the knowledge needed to make a fully informed decision about that particular franchise. Per the Federal Trade Commission, “the amended Rule requires franchisors to give prospective franchisees material information, including background information on the franchisor, the costs of entering into the business, the legal obligations of the franchisor and the franchisee, statistics on franchised and company-owned outlets, and audited financial information. In addition, if franchisors elect to make any financial performance representations, the amended Franchise Rule requires certain disclosure and substantiation for those representation.”
The FTC website, has a consumer’s guide link that will explain each of the sections listed above:
The Federal Trade Commission also publishes a Compliance Guide for the franchisors that will list all the information they must provide in an FDD:
Quick Note: The FDD and the information in these links are hundreds of pages long….my way to spell FUN is FDD. Who do you think writes these FDD’s? Franchise Attorneys! Of course they want to protect their client - the interests of the franchisors, and really the entire system. Which could include you if you become a franchisee. Having owned a franchise system, I would highly recommend having an attorney review the FDD and if needed the Franchise Agreement. Please note how I wrote: Franchise Attorney. Just like in the medical world you do not want an Orthopedic Surgeon doing your eye surgery, you also do not want an attorney who specializes in real estate, contracts or yes...even business law. Those rotate more around the corporate world. Franchise attorney is the specialty to hire for these lovely documents.
Now that we have entered the attorney & legal section, let’s get the foundation….are you sitting? These documents are not going to change. The purpose of hiring a franchise attorney is not to change the document. Sounds frustrating...it can be, but let’s keep investigating why. An easy comparison of the FDD is a bank mortgage contract. Are they scary? You bet! Do they walk through every possible worst case scenario, of course! Can you change your mortgage contract? No. We would like too! FDD’s are like mortgages. The franchise attorney will help explain it to you, walk through all the legal jargon and let you know all the ins and outs. Which will be mostly in favor of the franchise system. What’s the reason for this - to protect the system.
Let’s say you purchase a franchise. You know you’re going to work very very diligently, put in all the hours needed to grow and follow their proven system. But what if someone else in the system chooses not to? All of a sudden this other franchisee seems think they know better and makes decisions that will hurt the brand. You’re now part of this brand, so it will affect your business too. So here is the simple perspective to approach an FDD: treat it similar to dating & marriage. When you’re reading it from the perspective of ‘dating’ - read it carefully. Spend some time with it, read it a few times to get to know it well. It is going to seem scary from the outside. All these ‘what if’s’ will creep into your subconscious like little pests your brain is digging up. When you’re now married, that FDD feels similar to a nice warm security blanket.
You know that you will be one of those franchisees that is going to work extra hard to be successful - so the next logical question is: How much I can make? Item 19 is your ‘go to’ section! Will you get that coveted financial information - maybe. About 70% of franchisors will show financial performance representations. Some will choose to provide average sales of it’s franchisees, some will choose the top third, middle third and bottom third of franchisee’s sales, some will give the gross revenues for selected locations, some will give enough data for you to determine net profit or something close to it and some will give full P&L’s. If you want the franchisors to provide more data than what is in the FDD they cannot. The franchisors can only speak to what is written in the current FDD. What is the next logical step - speak to franchisee’s. This is your validation portion of the investigation. Legally they can speak to you about how much they make - if they wish to tell you. At the end of the day it only matters to a certain extent what someone is making. Are they following the system and making money? Are they really working in the business and making nothing? If they are making a figure that makes you fall off chair with excitement - excellent….validate why and how! If they are making a figure that makes you want to run for the hills….why and how? Get a good sampling of people to speak to, validate the system, the information, and the support.
For as scary, frustrating, confusing, informative and enlightening these FDD documents are, I hope you can see just how important they are in the entire process. Use them to your benefit. Get to understand the full scope of the business and people you’re looking to possibly enter into a business agreement / marriage. But hey, at least this one is only 10 years….but please first check your FDD.
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