Reviewing the Franchise Disclosure Document: What You Need to Know

When considering a franchise opportunity, one of the most critical steps is reviewing the Franchise Disclosure Document (FDD). This legal document is your window into the franchisor’s history, fees, obligations, and overall health of the system you’re about to join. By taking a thoughtful, thorough look at the FDD, you’ll gain the insights needed to decide whether the franchise is the right fit for your business goals.

The FDD is a comprehensive document required by the Federal Trade Commission (FTC) in the United States, designed to provide prospective franchisees with transparent information about the franchise offering. Its purpose is to help you make a well-informed decision by detailing everything from the franchisor’s background to potential risks, financial obligations, and legal considerations.

• Transparency: The FDD ensures franchisors disclose all relevant information, preventing surprises after you invest.
• Risk Assessment: The financial and legal details within the document help you gauge whether the franchise’s obligations and performance align with your goals and budget.
• Foundation for Due Diligence: Reviewing the FDD carefully is the jumping-off point for deeper research and consultation with lawyers or financial advisors.

Although the FDD is typically broken down into 23 distinct items, below are the highlights you should pay special attention to.

1. Franchisor Background & Business Experience (Items 1 and 2)

• Company history: Learn about the franchisor’s founders, parent companies, and evolution.
• Leadership experience: Get insights into the key executives’ track records, which can influence the brand’s vision and stability.

2. Litigation and Bankruptcy History (Items 3 and 4)

• Litigation: Check whether the franchisor (or its executives) has a history of legal disputes with franchisees or third parties.
• Bankruptcy: Be cautious if the franchisor or its principals have declared bankruptcy, as this might signal financial instability.

3. Initial Fees and Ongoing Costs (Items 5 and 6)

• Franchise fee: This one-time payment grants you the right to operate under the franchisor’s brand.
• Royalties and other recurring fees: Royalties, National Advertising Funds, and technology fees affect your bottom line, so it’s crucial to understand all ongoing costs.

4. Estimated Initial Investment (Item 7)

• Startup expenses: Review projected costs for equipment, leases, insurance, working capital and more.
• Range of investment: Pay close attention to the range provided and compare it to your financial capacity as well as your risk tolerance. If you’re seeking financing, these estimates can guide lender discussions.

5. Obligations and Restrictions (Items 8 through 15)

• Restrictions on products/services: Franchisors often regulate what you can or can’t sell.
• Territory rights: Understand whether you’ll have an exclusive territory, determine how many territories you may need to achieve your financial goals and the associated franchise fees and territory development requirements. 
• Advertising requirements: Some franchisors require specific marketing spends or participation in national campaigns.
• Operational guidelines: Check if there are mandatory hours, design standards, or supplier relationships.

6. Financial Performance Representations (Item 19)

• Earnings claims: Many franchisors provide financial reporting on their corporate store or franchisee results.  The best provide detailed financials up to and including full P & L data.  While helpful for creating your own assumptions, these are not guarantees and need to be carefully vetted as you talk to the Franchisor and their existing franchisees.

7. Outlets and Franchisee Information (Item 20)

• Current locations: Evaluate how many franchises the company operates, the closure rate, and whether new units are opening at a healthy pace.
• Contact information: Names and phone numbers of existing franchisees are included here or in an addendum within the FDD. I recommend calling them to gauge their satisfaction and gather insider insights, especially when it comes to support, training, marketing and again, financial expectations.

8. Contracts and Agreements (Items 22 and 23)

• Franchise Agreement: This is your legal contract with the franchisor. Review the renewal, transfer, and termination clauses carefully.
• Area Development or Multi-Unit Agreement: If you’re planning to open multiple units or territories, ensure the terms and timelines make sense for your growth strategy.
• Acknowledge Receipt: The final pages include a receipt acknowledging that you have received and reviewed the FDD.  Every franchisor will ask you to sign and return this..it doesn’t create any obligation on your behalf.

Read It Thoroughly

It may seem daunting—FDDs often exceed 200 pages—but scanning it is not enough. Familiarize yourself with each section before moving on.

Take Notes

Keep track of any red flags, questions, or inconsistencies. These notes will be invaluable during discussions with the franchisor or your advisor.

Seek Professional Advice

A franchise attorney can help interpret complex legal language, while an accountant or financial advisor can vet the financial implications. Getting expert guidance ensures nothing is overlooked.

Contact Current and Former Franchisees

The FDD includes contact details for existing franchisees. Speaking with them is one of the best ways to verify the information in the document. Ask about day-to-day operations, profitability, and the level of support they receive.

Compare with Other Franchise Opportunities

If you’re looking at multiple franchises, compare the fees, restrictions, litigation history, and financial performance representations side by side. This comparison will highlight which franchise aligns best with your needs and budget.

• Excessive Litigation: A high volume of lawsuits can indicate consistent franchisor-franchisee conflicts or systemic issues.
• Unclear Financial Projections: If the franchisor provides vague earnings claims or refuses to offer any data, approach with caution.
• Steep Initial Fees or Royalties: Excessive fees can quickly undermine profits; assess whether the franchisor’s support and brand equity justify the costs.
• Frequent Franchisee Turnover: If many locations are shutting down within a short timeframe, investigate the underlying reasons.

Reviewing the Franchise Disclosure Document is a critical milestone in your journey toward franchise ownership. Although it requires time and careful analysis, the FDD offers invaluable insights into the franchisor’s history, fees, responsibilities, and support systems. Armed with this information—and possibly with input from legal and financial professionals—you’ll be better positioned to make a confident, informed decision.

Questions about understanding or analyzing the FDD? Feel free to choose a time to talk for a more detailed discussion. Whether you’re a first-time buyer or a seasoned entrepreneur, having the right support can make all the difference in setting you up for success.