What is a Franchise Disclosure Document (FDD)?
Understanding the FDD
The Franchise Disclosure Document (FDD) is a legal document that must be given to everyone who is interested in buying a U.S. based franchise. The FDD shares essential information with potential franchisees to help them make an informed decision about whether or not to purchase the franchise.
The FDD details all of the rules and roles of both the franchisor and the franchisee. Every FDD is broken out into 23 sections called "items". These items show you everything that you're getting into from a legal and financial perspective. You must be comfortable with everything included prior to deciding to move forward with the purchase of the franchise.
The franchisor is required by the Federal Trade Commission to deliver the FDD to you no less than 14 days prior to awarding you the opportunity to purchase the franchise. This gives you ample time to familiarize yourself with everything included. Some franchisees elect to have an attorney read over the FDD to help get a deeper understanding of the obligations. If you choose to do so, be certain to consult with a qualified franchise attorney - NOT a general business attorney.
Below you will find a list of every item, their meaning, and helpful tips to consider when reading each.
Items contained in the FDD
The franchisor and any parents, predecessors, and affiliates.
This informs you on how long the franchisor has been operating, who owns the franchisor entity, if the franchisor has been sold (and to who), and lists any other business interests the franchisor owns.
Reveals all pending and prior legal disputes the franchisor has been/is involved in. Most mature (5 years or older) franchises will have lawsuits listed here. Be sure to read them thoroughly to identify any common themes and/or "red flags".
This is the section where you will find a list of all fees that must be paid to the franchisor immediately following the execution of the franchise agreement, and prior to you beginning opening procedures.
Estimated Initial Investment
This item shows you an itemized list of all expenses you will incur prior to opening your business, and any working capital you will need to have in your reserves to operate your business for at least 3 months. It will be represented using a range from low to high. It's always best to hope for the best and expect the worst, so getting close to the higher end is a good rule of thumb. Be sure to give this breakdown to your bank when trying to secure a startup loan.
This item shows you everything that you will be responsible for during the course of launching and operating your business.
Franchisor's Assistance, Advertising, Computer Systems, and Training
Here you will see what the franchisor provides the the franchisee during the pre-opening time and any ongoing assistance the franchisee can expect. Be sure that this description matches everything that you have been told during the discovery process.
Here you will find all trademarks that the franchise owns, as well as how you will be permitted to use those trademarks should you be awarded a franchise.
Obligation to Participate in the Actual Operation of the Franchise Business
If you're planning on running your franchise semi-absentee, or fully-absentee, pay attention to this section. Here you will find what your legal obligations are to participate in the operation of your franchise.
Renewal, Termination, Transfer, and Dispute Resolution
While a franchise is a lot like a marriage, it's not always, "til death do us part". Often times there is a time limit on a franchise with subsequent renewal periods. Understand everything about the term(s) prior to agreeing to move forward.
Financial Performance Representation
This is one of the most important items of the entire FDD. This is where you will find data pertaining to the potential revenue you can achieve with your franchise. Every franchise has the option to report anything, everything, or nothing here. But ask yourself this - if they are not reporting anything, why?
All franchisors must provide audited financials showing three years of statements. Pay close attention to these, they will help you determine if the franchisor has the financial ability to live up to its obligations.
The way that the franchisor ensures that it is complying with the FTC's rules is to have you complete a receipt upon receiving the FDD. Signing this in no way obligates you to anything.
This section gives you a list of all executives on the franchise and their responsibilities, background, and how long they have been in their current role. This will help you to understand if the franchise has the requisite personnel to help you launch and operate your new franchise successfully.
All bankruptcies involving the franchise, its predecessors, and its affiliates will be listed here. If the franchise has a lot of information in this item, RUN! This is a clear indication that the principals are not financially responsible.
All fees that you will be obligated to pay while operating your franchise. It is typically shown using a table and includes all fees that will be paid on a monthly/weekly/daily basis to the franchisor, its affiliates, and other approved vendors. Understanding this will help you get a clearer picture of what your overhead will be once your business is operational.
Restrictions on Sources of Products and Services
Informs you of where you will be able to source products and services for your franchise. It will also show you if the franchisor receives any financial gain from your use of these vendors. Be sure to ask existing franchisees if these restrictions help or hinder their ability to run their business profitably.
This will contain the details (if any) of the financing that the franchisor provides to its franchisees. Most of the time, this item will simply state that the franchisor does not provide any financing.
If the franchisor is providing a protected territory, this item will give a description of what that will look like. Franchises are not required to provide any protection or exclusivity, so if you want that, be sure that you're comfortable with this section before investigating any further.
Patents, Copyrights, and Proprietary Information
This shares the details of any patents, copyrights, or other proprietary information that the franchise owns not included in the trademark section.
Restrictions on What the Franchisee May Sell
Here you will find a list of all products and services that you are obligated and allowed to sell. If you were told about anything NOT listed here, be sure to bring that up to the franchisor prior to signing.
Shares the name of any person whose name or physical likeness is associated with the franchise. For example: If a sports figure endorses a fitness franchise, the details of that arrangement will be found here.
Outlets and Franchisee Information
This is where you will find the names, locations, and contact information for any past or present franchisee. It's always a good idea to reach out to as many of these individuals as possible to validate what the franchise is telling you.
This is where you will find any contract that you will be entering into as a franchisee.