How to Read Your FDD
Reviewing your FDD is an important step before becoming a franchisee. FTC regulations require any franchisor to give a potential franchisee 14 days before signing any franchise agreement. You should always take time and attention to review your FDD before signing a franchise agreement. Here are a few tips to make sure you catch some of the more important details contained in an FDD.
Every FDD will have 23 chapters, called Items. There are three Items in particular that you should start with to have a good idea about the viability and compatibility of a franchise system with your investment.
Item 3 lists any lawsuits that they have been involved (within the last five years) or are currently engaged. Anything that stands out such as suits from franchisees claiming fraud or misrepresentation should be big red flags that need to be addressed before seriously considering a franchise system.
Item 4 will contain any bankruptcies that the franchisor, related entities, or owners have undergone in the last ten years. I have only rarely seen bankruptcies listed but the few I’ve seen were related to parent companies in the distant past. Keep in mind that bankruptcy proceedings are public record and should you have any concerns about their bankruptcy, they will be able to provide more information.
The most important indicator of a franchise system’s health is in Item 20. Item 20 has a comprehensive list of franchise outlets. The tables will tell you whether the franchise is losing or gaining units as well as the status of current units. If a franchise systems is not retaining current units, whether a high number of non-renewals, transfers, or terminations, this should be another big red flag for any potential franchisees.
After you have carefully considered these first three Items, start from the beginning and read the Items in order. The first couple Items will provide a background into who owns the company, what the company does, and how their franchise system has evolved. Pay attention to any related companies or affiliates that you will be required to use in the franchise system. Sometimes franchise systems will have higher prices under their required vendors or affiliates.
Items 5 and 6 will contain the franchising fees and the royalties you will be required to pay. These are important to consider in your due diligence, giving you a good idea of what your operating margins should be. This will be analyzed in tandem with the next section , Item 7, which lists the estimated initial investment.
Item 19 can be an important piece of information. Some of the larger, more established franchise systems will detail their revenue and expenses of featured franchisees or sometimes the entire system. Smaller and newer franchise systems will not likely have much detailed information for a potential franchisee to digest, but be sure to spend some time here to understand what is provided to you.
Be sure to take notes on anything that you do not understand or have some concerns about. Having a trusted franchise law professional review the FDD with you can probably answer most of these questions. If not, then the franchisor will be able to clarify. Our flat fee FDD review can help you better understand your rights and obligations before joining a franchise system. Call Reidel Law Firm today at (832)510-3292 or use the email button below.