Before you buy a franchise, it's crucial to thoroughly review the Franchise Disclosure Document. This guide will detail how you can read this document more effectively so that you can get the most out of each disclosure you read.
What is a Franchise Disclosure Document?
It’s usually 100+ pages, and it will always be divided into 23 sections, or "items." In each item, franchisors are required to provide accurate and detailed information written in layman's terms.
The goal of an FDD is to allow prospective franchisees to review a franchise’s critical information from a business, legal, and financial framework free from the influence of a franchise’s marketing or spin.
What’s in this guide?
The FDD is an incredibly valuable resource. It’s just a little… long. My goal is to make this lengthy, dry document more accessible, and more interesting.
So, in this guide, I'll break down each of the 23 items in an FDD.
For each item, I’ll cover:
- what content to look for
- the purpose of the item
- questions to ask as you read the item
In short, this is a complete guide to help you read an FDD like an experienced, professional franchise investor.
With this guide by your side, you should be able to read FDD’s more actively – and with less overwhelm!
If you ever want to dig into more specifics than I’ve provided, I recommend visiting Cornell Law School’s resource on 16 CFR § 436.5 – the law governing how an FDD must be organized.
Where to find franchise investment ideas (and FDDs)
If you’d like to expand your network and review my favorite investment ideas, schedule a time to meet with me. (For transparency: My services are at no cost to you. When I successfully make a match between a franchise and franchisee, then the franchise pays me a referral fee. I only refer candidates to franchises that meet rigid criteria designed to ensure your success.)
If you’d like, I can also guide you to a selection of FDDs. Please check the bottom of this resource or, better yet, ask me in person.
Now, let’s begin our breakdown of the FDD, item by item.
Item 1: The Franchisor and Any Parents, Predecessors and Affiliates
Item 1 provides important information about the franchisor and its business background.
What’s in Item 1 of an FDD?
Item 1 includes the:
- name of the franchisor (including past or alternative names)
- business address
- business structure (e.g. LLC, corporation, etc.)
- number of years in business
- when they first started offering franchises
- number of franchise units currently operating
- franchisor's parent, predecessor, and affiliated companies
- other businesses in which the franchisor may be involved
What’s the purpose of Item 1 of an FDD?
Item 1 gives a comprehensive overview of the franchisor's business background and history. As you review this history, you’ll get insights into the stability and experience of the franchisor as a business partner.
Questions to ask as you read Item 1
As you read Item 1, you should seek to understand the relationships between the franchisor and its affiliates. You’ll also want to look out for potential conflicts of interest.
As you read Item 1, ask yourself:
- How many years has the franchisor been in business?
- How many years has the franchisor been offering franchises?
- Have there been any changes in ownership or management? Why?
- What other businesses is the franchisor involved in? How do these businesses fit into the franchisor's overall business strategy and goals?
A longer business history suggests a more established and financially stable business. A shorter track record portends higher risk, but this is usually offset by an appropriately discounted price. Either type is fine so long as it aligns with your risk tolerance.
If a franchisor has offered franchises for 15+ years, and they haven’t had many franchises shut down, then they likely have a wealth of experience in supporting and guiding franchisees. On the other hand, if a franchisor has less than 10 years of experience offering franchises, then the franchise is going to be less proven in different geographic and economic environments. This reveals a risk.
I like to see a franchisor with a long history of consistent ownership by the same group of people. If the franchisor has changed ownership or management multiple times, the business might be less stable and more prone to change. Do you want a business that changes direction every several years?
If the franchisor is involved in a variety of industries, that could show that they’re diversified and financially stable, but not laser focused on your franchise. On the other hand, if they’re only involved in a single industry, they might be more likely to keep up on the latest industry trends and roll out adaptations faster.
If a franchisor just acquired a new company to add to their portfolio, I’d be curious to know their goals and priorities. What synergies do they see with their recent acquisition? Are there any benefits for the franchise you’re looking at investing in? Has the company moved any of their top leadership over to manage the newly acquired business?
Item 2: Business Experience
Item 2 of an FDD lists information about the key individuals running the franchise.
What’s in Item 2 of an FDD?
You’ll see a list of:
- top executives with management responsibilities
This section includes information about the occupation and employer of each individual over the past five years, effectively serving as a "group résumé" for the leadership team.
What’s the purpose of Item 2 of an FDD?
Item 2 lets you assess the people you’ll work with. I suggest following them on LinkedIn and doing some light research online to learn more about them.
A franchise relationship extends over many years. You should make sure you feel confident that the people behind the franchise can help you when problems arise.
Questions to ask as you read Item 2
Consider your prospective business partners' experience in management and franchising.
- Do they have a proven track record at creating franchise systems?
- Is the leadership team’s business experiences relevant for this franchise?
- How long have they been with the franchise, and what have they accomplished?
- How actively are they involved in the day-to-day operations of the franchise?
- Do they have a diverse range of business experience and skills?
- What is their occupational background and who are their most recent employers?
- Have any key individuals faced legal or financial challenges in their careers?
Item 3: Litigation
In Item 3, you’ll learn about any legal actions taken by or against the franchisor. You’ll also see any legal actions taken by or against any of the franchisor’s parents, predecessors, or affiliates.
What's in Item 3 of an FDD?
When you read Item 3, you can expect to find:
- A list of all legal proceedings that the franchisor is currently involved in or has been convicted of in the past 10 years
- Details of each legal proceeding, including the court case number, the parties involved, and the status of the case
- Any other relevant information related to the litigation, such as settlements or judgments
What's the purpose of Item 3 of an FDD?
Item 3 provides you with full transparency about any legal issues that the franchisor faces. This is great, since it helps you anticipate legal issues that could foreseeably arise down the road.
Questions to ask as you read Item 3
You’ll want to know if any of the business’s core assets are vulnerable. On another level, you’ll also want to get a sense of whether the business carries out routine litigation to protect its assets, or resorts to lawsuits rather than amicably handling disagreements with franchisees.
As you read, ask yourself:
- How many legal proceedings is the franchisor currently involved in?
- Has the franchise been convicted of anything in the last 10 years?
- Is there a high number of lawsuits involving the franchisor or its affiliates?
- Are the lawsuits listed relevant to protecting intellectual property?
- Do any lawsuits listed threaten the franchise system’s viability?
- Does the franchisor have a tendency to use legal action to resolve disputes?
- Are the majority of lawsuits resolved without going to court?
I personally love when a franchise just writes, “No litigation is required to be disclosed.” To me, this signals a business that handles matters professionally without wasting time in court. That said, there can be times when litigation is appropriate, such as to protect a part of a franchise’s intellectual property or business system.
Item 4: Bankruptcy
Item 4 shows bankruptcy filings linked to a franchise.
What’s in Item 4 of an FDD?
Item 4 provides a list of:
- bankruptcy proceedings by the franchise or its predecessors in the last 10 years
- bankruptcy proceedings by any key franchise officers in the last 10 years
What’s the purpose of Item 4 of an FDD?
Item 4 gives you information on the reliability of the key figures in the franchise.
You’re looking for a track record of trustworthiness and financial responsibility. I recommend avoiding companies that have a poor financial history and a record of being less responsible.
Questions to ask as you read Item 4
I’m mostly concerned about the financial reliability of a franchise’s chairman, CEO and CFO. So, when I read Item 4, I’m looking for a clean report on these individuals.
Usually bankruptcy results in a healthy business restructuring. For this reason, I’m not overly concerned if a business shows bankruptcy in its rear view mirror so long as the officers have been replaced and the problems that led to bankruptcy have been resolved.
As you read Item 4, ask yourself:
- If any of the key officers have been connected to bankruptcy in the past, what was the context and what was the outcome?
- If key officers have been involved in bankruptcy proceedings, what does this suggest about the financial stability for the franchise?
- Is the franchise’s leadership team financially responsible and trustworthy?
Item 5: Franchise Fees
Item 5 details the fees that you as a prospective franchisee must pay to the franchisor before you open your franchise.
What's in Item 5 of an FDD?
You’ll get information about the dollar amount and timing of payments. Payment information is provided for:
- the franchise fee, a one-time payment for the right to use the brand and business model
- the territory or training fees, which may be separate or combined with the franchise fee
- the costs for any products or equipment the franchisor requires you to buy from them
Sometimes, a franchise will charge a fee for a background check and then apply that payment toward your franchise fee if you are approved.
What's the purpose of Item 5 of an FDD?
Item 5 gives full transparency about the fees that you’ll need to pay the franchise.
Questions to ask as you read Item 5
Franchise fees need to be reasonable and affordable if your franchise is going to succeed. So, pay attention to this section, and ask these questions to guide your reading:
- What is the total cost of the franchise fee, territory fee, and any other upfront fees?
- Are there any fees that are refundable? What are all the requirements for a refund?
- Are there any products or equipment that I am required to purchase from the franchisor? What is the total cost? Does the franchisor allow me to purchase from an alternative vendor if costs become unsustainable?
- Are there any hidden costs or fees that I should be aware of?
Item 6: Other Fees
Item 6 covers all other fees that you as a franchisee are required to pay to the franchisor or its affiliates. This includes ongoing fees for advertising, plus royalties, and any other fee the franchise will require you to pay.
What's in Item 6 of an FDD?
You’ll get a list of all recurring or isolated payments that you need to make to the franchisor or its affiliates.
For each fee, you’ll typically see:
- the names of the fee
- the amount
- the due date
- an explanation of the fee
What's the purpose of Item 6 of an FDD?
Item 6 provides transparency about all potential costs you should expect once you've paid your initial franchise fees. The franchise is required by law to list everything, including any “fine print” provisions.
It takes time to read all this, so this is one section I would pay more attention to later, once I’ve ensured that the rest of the FDD sounds good. However, when you are ready to give this a closer look, the information covered here can help you enormously with planning your business.
Questions to ask as you read Item 6
- What royalties do I need to pay on gross revenue?
- How much should I budget monthly for all the other fees I need to pay?
- Are the ongoing fees, such as royalties and advertising, reasonable in comparison to the overall cost of the franchise?
- Are there any provisions that could allow additional fees or charges in the future?
- Will I have to pay a fee if I want to sell my business before the end of my agreement?
If you don't understand or agree with certain fees, make a note and ask your franchisor for a more detailed explanation. You deserve to feel good about the entire deal, and it’s useful for franchisors to be aware of provisions that concern prospective franchisees.
Item 7: Estimated Initial Investment
Item 7 provides a comprehensive list of all expenses you can expect to incur when opening and operating your franchise for the first three months.
What’s in Item 7 of an FDD?
The estimated initial investment will probably include:
- the initial franchise fee
- lease payments
- leasehold improvements
- equipment and supplies
- a point of sale system
- professional fees
- travel and living expenses for training
- utility deposits
- legal and accounting fees
- pre-opening payroll and employee training expenses
The section typically also includes a recommendation for a cash cushion you should set aside.
What’s the purpose of Item 7 of an FDD?
The purpose of this section is to ensure you have enough cash to operate comfortably during the first few months of running your business.
Questions to ask as you read Item 7
- Do the estimated expenses align with my own estimates and budget?
- Are there any unexpected or unfamiliar expenses that I should ask the franchise about?
- Am I able to pay all these expenses with an SBA loan or other financing?
- How much working capital should I have upfront? How much cash should I have reserved to pay the operating expenses of the business until the business can support itself?
Item 8: Restrictions on Sources of Products and Services
Item 8 is all about the products and services that a franchisee is required to purchase from the franchisor or from approved third-party suppliers.
What's in Item 8 of an FDD?
Item 8 will detail which items are restricted, which can be purchased from approved suppliers, and which are unrestricted:
- Restricted purchases are products and/or services that the franchisee is required to purchase directly from the franchisor. Franchisors often use this to increase their revenue.
- Items designated for purchase from approved suppliers are a separate category. These requirements ensure consistency across locations and protect the brand.
- Unrestricted purchases are products that a franchisor indicates the franchisee is free to purchase from wherever they choose. This might include everyday items like towels or napkins.
What's the purpose of Item 8 of an FDD?
This section serves two essential purposes:
- It allows a franchise to protect its proprietary information by controlling how its products are made.
- It informs you, the franchisee, about your obligations (and opportunities) when you procure materials.
Many franchises use restricted purchases as unofficial royalties. You pay the franchise a little profit margin each time you need to buy materials. This is why franchises are required to disclose all restricted purchases.
Questions to ask as you read Item 8
- Are there any products or services that I am required to purchase from the franchisor or from approved, third-party suppliers?
- How does the cost of these required products and services compare to what I could potentially find elsewhere?
- Is the list of required products and services reasonable and necessary?
Item 9: Franchisee's Obligations
Item 9 outlines the principal obligations of the franchisee after signing the franchise agreement. This includes any obligations outlined in the franchise agreement and any other agreements that the franchisee is required to fulfill.
What's in Item 9 of an FDD?
Item 9 will consist of a table outlining the principal obligations of the franchisee under the franchise agreement.
What's the purpose of Item 9 of an FDD?
Item 9 helps you, the franchisee, keep track of all your obligations to the franchise.
Questions to ask as you read Item 9
- Are there any specific obligations that I am not comfortable with or capable of fulfilling?
- How will these obligations impact my day-to-day operations as a franchisee?
- Are there any additional agreements or contracts that I will be required to sign? What are the terms of these agreements?
- With all the obligations I see, am I confident that I will have an easier path buying a franchise rather than starting an independent business?
Item 10: Financing
Item 10 is all about financing options available from the franchisor. This is typically a brief section, since most franchisors do not offer in-house financing.
What's in Item 10 of an FDD?
If the franchisor offers financing, this section will detail their financing terms.
Franchisors may offer leasing arrangements, loans, installment plans, or nothing at all.
What's the purpose of Item 10 of an FDD?
Getting financing from a franchise can be a helpful option. So, Item 10 lets you see what, if any, financing options are available from the franchise you’re interested in.
Questions to ask as you read Item 10
- Does the franchisor have relationships with third-party lenders that they commonly work with?
- Are there any specific requirements that must be met in order to qualify for financing from the franchisor or third-party lenders?
- Is financing from the franchisor or third-party lenders a good fit for my financial situation and goals?
- What costs are required to obtain financing from the franchisor or third-party lenders?
Item 11: Franchisor's Assistance, Advertising, Computer Systems, and Training
Item 11 outlines the systems and support that the franchisor provides to help the franchisee succeed. This includes assistance before, during, and after the opening of the franchise, as well as advertising, computer systems, and training.
What's in Item 11 of an FDD?
In Item 11, you can expect to find:
- a list of the systems and support provided by the franchisor
- details on the assistance provided before, during, and after you open your franchise
- information on advertising, computer systems, and training that the franchisor offers
What's the purpose of Item 11 of an FDD?
Item 11 clarifies the structure of the business relationship between the franchisor and franchisee.
The whole point of buying a franchise is to buy access to the franchise systems. So, this part of the FDD gives you a clear idea of the value you’re purchasing.
Questions to ask as you read Item 11
- What type of assistance does the franchisor provide before, during, and after the opening of the franchise?
- How will the franchisor support the franchisee in terms of advertising and marketing?
- What training, including ongoing training, will the franchisor provide?
- What advertising campaigns is the franchisor responsible for, and what is the franchisee responsible for?
- How is the franchisor's computer system set up? What technology will the franchisee be required to use?
- Are there any additional fees for the use of the franchisor's computer system or for ongoing training and support?
Item 12: Territory
Item 12 discusses the specific minimum geographic area granted to the franchisee. This may be defined by “a specific radius, a distance sufficient to encompass a specified population or another specific designation.”
What's in Item 12 of an FDD?
Item 12 clarifies:
- the minimum area granted to the franchisee
- any restrictions on the territory
- whether the territory is exclusive
What's the purpose of Item 12 of an FDD?
Item 12 informs you about the amount of territory you’ll hold.
Questions to ask as you read Item 12
- What is the size and scope of my territory?
- Are there any restrictions on my territory?
- What is the process for the franchise approving the territory that I want to buy?
- How is my territory defined (e.g. by radius, population, or another designation)?
- If the franchise defines territory by population, what census data will they use? Has the population grown more since then (giving me some bonus value)?
- Is the territory sufficient to support my business and allow me to achieve success?
- Are there any other franchisees operating in close proximity to my territory? Could this impact my business?
Ideally, you want a lot of territory to prevent encroachment down the line. As a franchise matures, “impact issues” from a competing franchise location are one of the most common sources of friction between franchisors and franchisees.
Typically a franchise will offer you a chance to buy more territory upfront at a discount. If you can afford it, and you feel you would regret not buying it, you can purchase the additional territory so that you can open additional locations when you’re ready.
Item 13: Trademarks
Item 13 is a list of all registered trademarks. Typically a franchise will share thorough information including the registration number and registration date.
What’s in Item 13 of an FDD?
In Item 13 of an FDD, you will find a list of all registered trademarks owned by the franchisor, along with the relevant registration information.
- trademarks like logos, symbols, trade names, etc.
- registration information, including exclusivity from competitors and trademark durability
- information on any contested trademarks
What’s the purpose of Item 13 of an FDD?
The franchise brand is a big asset. Item 13 confirms what exact branding you can use when you operate your franchise.
Questions to ask as you read Item 13
- What trademarks has the franchisor registered, and what is the registration information for each?
- Are these respected brand names and trademarks? What kind of reaction do people have online when I search these keywords on social media?
- Are there any potential issues or challenges with the trademark registration or use that I should be aware of?
Pay attention to the registration information for the franchisor’s trademarks. Proper registration ensures that the franchisee has protection from competitors using the trademarks. Additionally, you should see assurances that the trademarks will be available for the long term.
Contested trademarks can pose a risk to your franchise value. So, if you see this, consider whether the contested trademark is essential to your business.
Item 14: Patents, Copyrights, and Proprietary Information
This section of an FDD provides information about the franchise’s other intellectual property.
What's in Item 14 of an FDD?
Item 14 will show:
- any patents, copyrights, or proprietary information, which are material to the franchise
- the franchisee’s rights to these materials
What's the purpose of Item 14 of an FDD?
As a franchisee, understanding the franchise’s intellectual property will help you better understand a particular franchise opportunity.
In most cases, a franchise will not have any patents to their names. However, if the franchise you’re researching does have any relevant patents, this can certainly give you a leg up over your competitors.
Questions to ask as you read Item 14
- If a competitor comes along, will your franchise have anything special going for it to give you an edge other than branding?
- How does the franchisor's intellectual property contribute to the value of the franchise?
- Are these intellectual property rights adequately protected?
Item 15: Obligation to Participate in the Actual Operation of the Franchise
In Item 15, the franchisor discloses the direct involvement required from the franchisee.
What's in Item 15 of an FDD?
Item 15 contains:
- the level of personal involvement the franchisee must apply in operating their business
- any exceptions or exclusions to the required involvement
What's the purpose of Item 15 of an FDD?
Item 15 allows franchisors to directly address their position on semi absentee business ownership.
Some franchises have found that they get the best results when a franchisee is personally involved in running the franchise. As a result, they may stipulate a certain amount of your direct involvement.
Other franchises are satisfied to allow you to hire someone to manage your business while you take a backseat as a passive owner. Usually, this is conditional on the manager you hire completing the franchise training program and signing a confidentiality agreement.
In the event that your franchise underperforms, your franchisor will almost certainly ask about your level of involvement. If you were to sue a franchisor for lack of results, one of the franchise’s most important defenses will be to examine any discrepancies between your level of engagement and the level of engagement stipulated in the FDD.
Questions to ask as you read Item 15
- How much time will I need to be directly involved in operating the business?
- Are there any exceptions or exclusions to the required level of involvement?
- Do I have the time and energy to fulfill the required level of involvement?
- Is the required level of involvement realistic and feasible for me? Is this what I want at this point in my life?
Item 16: Restrictions on What the Franchisee May Sell
Item 16 lets a franchisor spell out any limitations on what a franchisee can sell.
What's in Item 16 of an FDD?
Item 16 lays out limits on whether you:
- can only sell the franchise’s goods and services
- must sell all of the franchise’s goods and services
- can modify the franchise’s goods and services
What's the purpose of Item 16 of an FDD?
Franchises want to maintain consistent standards and a consistent customer experience across all their locations.
To achieve this, they need to sell a consistent set of products and services at each franchise location. They also need to prevent locations from selling products and services that don’t fit with the brand.
Some franchises are more flexible than others. McDonalds is famous for some pretty interesting variety on their menus!
In any case, Item 16 will make it clear what is and isn’t allowed.
Questions to ask as you read Item 16
- Given that what people want to buy is different in different geographic locations, how will franchise restrictions on what I can sell limit my ability to generate revenue?
- Are there any potential conflicts between the restrictions outlined in Item 16 and my own business goals?
- Are these restrictions overly aggressive?
- Does the franchise give itself the right to add more restrictions in the future?
Item 17: Renewal, Termination, Transfer and Dispute Resolution
Item 17 helps franchisees understand their options when it comes to renewing or ending their agreement with a franchise. It furthermore provides clear remedies for disagreements that may arise between the franchisor and franchisee.
What's in Item 17 of an FDD?
Item 17 provides:
- a summary of 24+ provisions related to renewal, termination, transfer, and dispute resolution
- a table showing where you can find each provision
What's the purpose of Item 17 of an FDD?
To prevent any perceived injustices down the road, take a close look at Item 17. This is where the franchise has clearly documented a lot of information that can potentially cause serious disputes.
So long as you (and preferably, your trusted attorney) are comfortable with the provisions outlined here, then it’s safe to proceed (to reviewing and approving the other items in the FDD).
Questions to ask as you read Item 17
- What are the terms and conditions for renewing the franchise agreement?
- Under what circumstances can the franchise agreement be terminated, and what are the consequences?
- Can the franchise agreement be transferred to another party, and under what conditions?
- How are disputes between the franchisor and franchisee resolved, and what are the consequences if a resolution cannot be reached?
- Does the franchisor have the option to purchase your business?
- If you need to go to court, what state would hear your case?
Item 18: Arrangements with Public Figures
Item 18 provides information on any relationships the franchise has with public figures, including the terms of these relationships.
What's in Item 18 of an FDD?
In Item 18, you’ll learn about:
- any compensation or benefit that public spokespeople receive
- any duties public figures have within the franchise structure
- any investment the public figures have in the franchise
What's the purpose of Item 18 of an FDD?
It’s useful to know about any public figures who are involved in promoting a franchise. Public figures can boost public interest and trust in your franchise. They can also occasionally undermine a franchise. Fortunately, franchises are typically great at responding whenever a figure no longer fits with your franchise.
Questions to ask as you read Item 18
As you read Item 18, consider the following questions:
- Are there any restrictions on the use of the public figure's name or image in advertising or promotions?
- How long have the relationships with the public figures existed, and how likely are they to continue for the next 5, 10, or more years.
- How does the presence of a public figure in the franchise's marketing materials impact the overall image and branding of the business?
If you ask me, a public spokesman can be one of the great benefits of a franchise. You may not be able to afford a celebrity spokesperson if you’re operating an independent business in Wisconsin. But, through the power of franchising, you can now ride on the coattails of a national branding campaign centered on a public icon.
If the franchise you’re researching doesn’t have a celebrity spokesperson, no worries. But if they do, it can be a nice bonus.
Item 19: Financial Performance Representations
Any financial performance representations made by the franchisor must be in writing and included in the FDD in this section.
What's in Item 19 of an FDD?
Item 19 contains information about “actual or potential sales, costs, income, or profit”.
If the franchise chooses not to make financial representations, then they must write: “We do not make any representations about a franchisee's future financial performance or the past financial performance of company-owned or franchised outlets.”
What's the purpose of Item 19 of an FDD?
Item 19 prevents franchises from making unfounded claims or covert promises about a franchise’s profitability. By law, franchises are required to document plainly all financial representations that they intend to share with you.
Questions to ask as you read Item 19
You should ask yourself:
- Is this financial information specific and detailed? Can I really make a financial projection from this that I can take to the bank for a bank loan?
- Are all financial performance representations supported by evidence?
- If the franchisor does not make any financial performance representations, what is my plan to gather information and evidence directly from franchisees?
I recommend focusing on franchises that make financial representations. These are businesses that have a lot going for them, and they’re not afraid to show results.
Today, the majority of franchises don’t make financial representations. They may not have accurate profit and loss statements from their franchisees, or it may be too time consuming for the franchise to collect all this data. Another reason is that representations open them up to litigation.
If your franchise does not provide financial data, then you will have to do the legwork of speaking to other franchisees to learn what kind of financial results franchisees are achieving.
Item 20: Outlets and Franchisee Information
Item 20 provides detailed information on the current and past status of the franchise system, including the number and location of franchised and company-owned outlets, as well as information on transfers of outlets from franchisees to new owners.
What's in Item 20 of an FDD?
In Item 20, you will find 3 years of data covering:
- the number of systemwide outlets, including both franchised and company-owned outlets
- the number of outlets that transferred from franchisees to new owners (other than the franchisor)
- franchised outlets that have opened, closed, or transferred ownership
- the status of company owned outlets
- the number of outlets expected to open in the coming years
What's the purpose of Item 20 of an FDD?
Item 20 helps you see how a franchise is growing or regressing over time.
Use Item 20 to assess the sustainability of the franchise system.
Questions to ask as you read Item 20
As you read through Item 20 of the FDD, consider the following questions:
- Has the system grown or declined over the past three years?
- What percentage of the system has changed hands in any given year?
- Given market conditions, has there been an excessive number of outlet abandonments or closures relative to other business opportunities?
- Are the projected new franchised outlets realistic and achievable, or do they seem overly optimistic?
In general, I like to see less than 10% of a system changing hands in any given year. There are always going to be some sellers, even when business is going well. Owners may sell their franchise to pay for expenses related to retirement, senior care, or other life goals. 10% annual churn makes sense to account for this.
However, if you see more than 10% of a system changing hands each year, then franchisees are likely selling their business for undesirable reasons. This is a red flag, and I’d recommend asking a franchise representative why they think so many franchisees are selling.
Personally, I am not so concerned about projected new franchise outlets. No one knows for certain how many new outlets a franchise will open, and historically these estimates have not been that accurate.
Item 21: Financial Statements
Item 21 provides audited financial statements from the franchisor.
What's in Item 21 of an FDD?
In Item 21, you’ll find:
- balance sheets for the past 2 years
- income statements for the past 3 years
What's the purpose of Item 21 of an FDD?
Item 21 should give you a clear view of the financial stability of the franchise.
Questions to ask as you read Item 21
As you review the financial statements in Item 21, consider the following questions:
- Is the franchisor financially stable?
- Is the franchisor's financial performance improving or declining over the past few years?
- Do the financial statements follow generally accepted accounting principles?
If you don’t have a background in accounting, get in touch with a CPA or franchise consultant who can look over Item 21 with you. It’s critical to understand a franchise’s balance sheets and income statements so you can validate that the franchise is financially stable. Just make sure your CPA knows they're only here to explain things and not to give you their opinion on whether you should buy the business or not.
Item 22: Contracts
Item 22 lists all the contracts that you will need to sign if you choose to open a franchise.
What’s in Item 22 of an FDD?
Item 22 contains:
- the franchise agreement
- any lease, options, or purchase agreements that you will be required to sign
What’s the purpose of Item 22 of an FDD?
Item 22 lets you see the legal relationship that will exist between you and the franchisor should you decide to become a franchisee.
Questions to ask as you read Item 23
There’s only one basic question you need to answer here:
- Am I comfortable signing all of these documents?
Because these agreements are legally binding, I strongly recommend consulting with your own franchise attorney – one who specializes in reviewing FDDs. You should make sure that you understand each term, and you should invite your attorney to raise any questions or concerns they have as they review the documents as well.
Let your attorney know that you’re not looking to change or negotiate the contract. You’re just looking for legal advice on what the contract says and how it affects you. (I know a number of franchise attorneys who I trust, so please email me if you’d like a referral.)
Item 23: Receipt
Item 23 is a one-page document that you can sign to acknowledge that you’ve received the FDD.
A franchise that sends you a FDD will most likely ask you to digitally sign for the FDD. This confuses some people. Just understand, you’re not signing that you’re buying the business; you’re just signing to acknowledge that you received the FDD.
What’s in Item 23 of an FDD?
Item 23 contains:
- a confirmation that you’ve received the FDD
- your rights under the FTC
What’s the purpose of Item 23 of an FDD?
Item 23 is a bit of a formality. Oddly enough, you usually don’t need to sign this receipt or return it to the franchisor. It’s just for your records.
Questions to ask as you read Item 23
You don’t need to be concerned about any of the content in Item 23.
Exhibits are additional documents included with the FDD that provide extra information about the franchise opportunity. These exhibits are legally binding, so you should review them carefully.
Some exhibits you can often find include:
- a template version of the franchise agreement
- legal contracts that you may need to sign
- a list of all current franchisees
- a table of contents from the operations manual
- additional financial statements
The FDD is the ultimate reference tool for studying a franchise business.
It also tends to be long, so break out your highlight markers and sticky tabs (real or virtual).
“Read carefully” is a common platitude. I encourage you to use the questions I’ve outlined to read FDDs actively. While an FDD will answer many of your questions, it will also raise new questions for further research . So, when you’re finished reading, follow up to get the answers to your outstanding questions.
- Ask the franchisor about anything you don’t understand or are concerned about.
- Ask other prospective franchisees you meet what concerns they have about the franchise.
- Network with other franchisees and ask them questions to fill in any gaps in your knowledge, especially if the franchise has limited financial performance representations.
Finally, use your judgment to make the business decision about whether to join a franchise. I love when I read an FDD only to confirm that a franchise is just what it purports to be. Of course, if you’re unsatisfied after doing your due diligence, you should never be afraid to leave a deal.
To take advantage of my expertise as a franchise consultant and receive personalized assistance in navigating the world of franchising, don't hesitate to reach out. I am here to help you find the perfect franchise opportunity and make an informed decision. I’m compensated by franchises themselves, so you do not have to worry about accumulating consulting fees.
If you’re ready to explore the best franchises in my book, schedule a free consultation today.
Will the FDD provide information on a franchise’s competitive landscape?
No. The FDD focuses on the relationship between the franchisor and the franchisee. So it will not include information on a franchise’s competition or any qualitative competitive advantages.
Why don’t I don’t see any information in the FDD about why I should join the franchise?
The FDD is not designed to share any promotional information about why you should join a franchise. The sole purpose of the FDD is to ensure that you are an educated consumer. The US government wants to make sure that you have information about all critical points you should know before contracting with a franchise.
What should I do if I don’t see any red flags, but the franchise doesn’t look that promising?
That’s actually the point of the FDD! The FDD lets prospective franchisees evaluate franchise business opportunities based on financial performance and other nuts and bolts business considerations. The structure and requirements of an FDD prevents franchises from using marketing to cover up a bad or mediocre business.
If you aren’t feeling bullish after reviewing an FDD, I’d encourage you to schedule a free meeting with me so we can discuss other opportunities that are more promising.
Do FDDs need to be mailed?
In the past, FDDs were thick, bound documents. Not surprisingly, they’re now delivered digitally as PDFs. Delivery time has been cut accordingly. 🙂
Where can I read sample FDDs?
Reading sample FDDs is a great way to hone your experience assessing these documents, although it is a time consuming hobby!
There are other websites where you can read free FDDs. However, often the franchises on these sites are not the highest quality.
What states have publicly available FDDs?
The easiest one to search is Wisconsin’s. Just type in the name of the franchise you want to find and click “Search”. Unfortunately, many of the franchise documents are expired in the database. However, you can usually find some FDDs if you’re open to trying a few searches.
When will a franchise share their FDD?
Franchises have their own policies on when they share their FDD. Usually a franchise will ensure that a candidate is serious and qualified.
By law, a franchise is required to show you their FDD two weeks before they ask you to make an investment decision.