Navigating the franchise business can be tricky if you have not done your homework and made sure you have a team of experts helping you out. One of the most important documents you will receive as a potential franchisee is a financial disclosure document also known as the FDD. The FDD is a legal document that lays out all the information about the franchisor and the franchise system.
About two weeks before you sign the franchise agreement, you will be given the FDD from the franchisor as mandated by the Federal Trade Commission.
Here are the top three things you should know about the FDD:
Pay attention to these key items in the FDD.
Item 3: Litigation.
All current and past criminal and civil litigation for the franchisor, both those against them and those they are pursuing. Consider it a red flag if you see a bunch of lawsuits from franchisees against the franchisor or if there is a pending class action by consumers. These things could bankrupt the company. However, keep in mind that it is natural for larger franchisors to have more pending cases of litigation than smaller ones.
Item 4: Bankruptcy.
In this section will be listed any bankruptcies that the franchisor or its management is going through.
Item 5: Initial fees.
Here is where you will see exactly what you will be expected to pay to initially to open up your franchise unit. Two things to keep in mind is that sometimes these fees are negotiable so talk to the franchisor if you are interested in haggling. Second if the fees are listed as a range, ask if your fees will be on the lower or higher end.
Item 6: Other fees.
This section will include other fees or payments you will be required to pay. Keep in mind that not all fees are listed here so make sure you do your research so you are prepared for any unexpected costs.
Item 7: Initial investment.
These costs can vary so be sure to talk to other franchisees who are more experienced and find out how much money they needed to put up front before their business became profitable and how much of a salary they were able to draw in their first couple of years.
Item 11: Franchisor’s obligations.
This is the part of the document which should outline what services you can expect from the franchisor like site selection, training, marketing/advertising, and developmental and operational assistance. Watch the language used in this section so it is clear what they are required to provide you and what they “might” offer you.
Item 12: Territory.
Here is where you will see if you have any exclusive rights to any territory. Keep in mind that when you renew your contract these rights may change. Stay away from franchisors who don’t offer you any territory protection at all.
Item 13: Trademarks.
Any pertinent information about the franchisor’s trademarks and trade names will be included here.
Item 14: Patents, copyrights and proprietary information.
Read this section for clear instructions on how you can use the patents and copyrights.
Item 17: Renewal, termination, transfer and dispute resolution.
This section will lay out clearly what your rights are as a franchisee and what rights you are giving up to the franchisor to be part of their program. Misunderstandings about this can cause major problems down the pike later so make sure you have a clear understanding. If you are unsure about anything, ask questions before you sign the agreement. Two important things to nail down in your negotiations are the length of renewal periods and how many you are entitled to.
Item 18: Public Figures.
If any celebrities or public figures are a part of the brand, their names and how much they are paid will be in this section.
Item 19: Financial performance.
Not all franchisors will provide information about their financial performance if they do not lay it out here ask them one on one or reach out to a few of their current franchisees for some of this information.
Item 20: Franchisee information.
Pay attention to how many units the franchisor has taken back and resold. A high number could indicate a high turnover. If contact information is provided for franchisees who have left the system, then see if you can reach out to them and pick their brain about the pros and cons of the franchisor.
Item 21: Financial statements.
The franchisor should provide you with copies of financial statements for the last three years. Make sure to have an accountant who specializes in franchising to look them over for you. Make sure you pay attention to both the balance sheet and the income statement. Remember that a franchisor with a troubling financial outlook will spell trouble for you if they continue to have problems.
Item 22: Contracts.
Check to make sure that any contracts listed in this section are attached to the FDD. Don’t forget to go through each of them very carefully before making any final decisions.
Make sure there is consistency between all legal documents.
Another thing you will want to watch out for is that the information here in the FDD is consistent with the information in the franchise agreement. If there are a lot of discrepancies, then you should raise your concern to the franchisor. You will want to make sure that they are not trying to hide anything from you.
Use this information to reach out to franchisees
If you have not already, use the information in the FDD to reach out to several current franchisees to pick their brains on what it is really like to be a part of the franchise system. Don’t be afraid to ask for particulars like how long it took them to make a profit after their initial start-up and what their initial investment was and how much in fees so they have to pay. Also ask if they have a good relationship with the franchisor and whether or not they are happy with their choice.
Overall, the FDD is a very important document that should be reviewed carefully and evaluated before you sign the franchise agreement. Don’t be afraid to consult with an attorney who specializes in franchising for help.
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