“I’m sorry, I don’t speak legalese. Only English,” stated the perplexed entrepreneur.
Prospective franchisees can sometimes be intimidated by a certain legal document. The “terrifying” uniform franchise disclosure document.
But before entering into any business relationship using your John Hancock, there’s a diligence process to follow.
We’ll outline this method here. Let’s start you down the path towards stellar gross sales in your first franchised business.
What Is a Franchise Disclosure Document (FDD)?
If you’re thinking of buying a franchise business, step one is reading the franchise disclosure document (FDD). It contains all the information you need to know about the franchise.
Your zoomed out view of the venture contains:
- Financial statements
- Risks involved
Acting as a snapshot of the company, it is your first impression. As such, it should be organized, well structured, and be simple enough for a non-lawyer to comprehend.
It is provided prior to joining in the partnership. Understanding there will eventually be an initial franchise fee that is non-refundable, pay close attention to the document.
How Does It Clarify a Franchisee’s Obligations?
Reading and understanding the franchise disclosure document is essential for making an informed decision. Whether or not to make an initial investment!
Besides your expectation to protect any proprietary information, there’s other outlined areas you’ll be accepting ownership over. That’s of course if you decide to move forward with the partnership.
Expect franchisor’s assistance, advertising, computer systems, and training to be clearly displayed.
Take note of other franchisee information if it’s available as well. Why?
You’ll want a network of like-minded individuals to help you advance and grow the franchise.
What Should You Look for When Reading Your Franchise Disclosure Documents?
So, how do you go about reading and understanding your franchise disclosure document (FDD)?
Inside Information for a Prospective Franchisee
Here are a few tips:
- Scan the table of contents
- Pay special attention to the section on financial performance representations. This has information on the franchisor’s historical sales, unit financial performance, and profitability.
- Study the section on risks carefully. One example may be prior litigation against the franchisor. This will help you understand the potential downside of making the purchase.
- As a prospective franchisee, take your time reading the FDD. This is an important decision, so you’ll want to make sure you understand everything.
- If you have any questions about the FDD, be sure to ask the franchisor for clarification. They should be able to answer any questions you have about the franchise business.
By following these steps, you can be sure that you’re reading and understanding your FDD correctly. This will help you make an informed decision about whether or not buying the actual operation is the right move for you.
How Can the Franchise Disclosure Document Help You Make an Informed Decision About Franchising Your Business?
Reviewing your FDD is an important step before becoming a small business owner.
Federal Trade Commission (FTC) regulations require any franchisor to give a potential franchisee two weeks before signing any franchise agreement.
Besides determining the level of their business experience, you’re assessing the long-term prospect of this franchise. Surely you don’t want to go through the initial registration if it won’t further your future retirement goals.
Due Diligence Is a Franchisees Territory
Running a business can be a major undertaking for anyone. Your responsibility to yourself and your family is a thorough review of all available details.
Within the pages of this report, there are a few areas that will aid your decision making:
- Audited financial statements
- Initial fees
- Financing arrangements
- Patents, copyrights, and proprietary information
- Public figures
- Other fees
- Any past criminal activity
A franchisor must detail this information so you can put together a reference table.
Use a simple Excel spreadsheet or piece of lined paper to create it. You don’t need many fields, but the goal is to discern how realistic the endeavor is.
The length of your business experience may factor into this assessment. But it’s not a substitute for using your intuition and processing the details in a quiet setting.
Are There Any Specific Sections of the Franchise Disclosure Document That You Should Pay Close Attention To?
There are three Items that you should start with to have a good idea about the wisdom of investing in the franchise system.
Item 3 lists litigation history.
They must disclose any current or previous lawsuits (within the last five years). For example, suits from franchisees claiming fraud or misrepresentation should raise a red flag. Before seriously considering a franchise model, you’ll want to address this with this owner.
There’s another piece of information they must disclose.
Item 4 will contain any bankruptcies that the franchisor, related entities, or owners have declared in the last ten years. I’ve only seen a few listed and they were related to parent companies in the distant past.
Keep in mind that bankruptcy proceedings are public record. Should you have any concerns, the franchise owner will be able to provide more information.
The most important health indicator of a franchise offering is in Item 20.
Here you’ll find a comprehensive list of franchise outlets. The table format is meant to tell you whether the franchise is losing or gaining units and the status of current company owned outlets.
If a franchised business is not retaining current units, whether a high number of non-renewals, transfers, or terminations, this should be another red flag for any potential franchisees.
Other Areas for Prospective Franchisees To Read Carefully
After you view these first three Items, go back and examine the entire document. The first couple of items will provide biographical and professional information.
- Background into who owns the company
- What the company does
- 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 they will have higher prices under their required vendors or affiliates.
Items 5 and 6 will contain the initial 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 too.
Some of the larger, existing franchises will detail their revenue and expenses of featured franchisees or sometimes the entire system. Because smaller and newer franchise systems will not likely have much detailed information for a potential franchisee to digest, spend time on these condensed financial statements.
What Questions Should You Ask Your Franchisor Before Signing the Franchise Agreement?
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, approach the franchisor for clarification.
Getting Answers From the Franchise Owner
Parts worth asking questions about:
- Operational structure
- Transfer and dispute resolution
- Upfront fees
- Parents predecessors and affiliates
- Franchisee’s obligations
Our flat fee FDD review can help you better understand your rights and obligations before joining in a franchise relationship.
That way, you can confidently sign the franchise agreement and start the adventure!
How Do You Get a Copy of Your Franchise Disclosure Document if You Don’t Have One Already?
The federal franchise rule carries certain legal obligations with it. Mainly, it states a franchisor must give you a copy of the FDD at least 14 days before you purchase a franchise.
Exact timing may vary state to state. Regardless, the point is to allow you sufficient time to weigh the pros and cons of joining in this legal relationship.
Why the Franchisor Must Provide the Franchise Disclosure Document (FDD) for the Actual Operation
As a fixture in the business world, the franchisor’s assistance is required by law, but also to uphold their reputation.
If the franchise owner wasn’t aware they must disclose this document in the allotted time, don’t sign any agreement until they have.
A final note on the rule. The declaration part of the FDD must be written in simple English, not legal jargon.
Thank goodness, am I right?
Reidel Law Firm and Your Franchise Disclosure Document
As experts in franchise law, we assist your review of the franchise disclosure document.
Other ways we assist:
- Explaining state franchise laws
- Dispute resolution
- State or federal injunctions
- Reviewing related agreements
By effectively managing risk and maximizing opportunities for businesses we answer the needs of our clients wherever and whenever they arise.
From looking over a franchise agreement to legal disputes, we support your small business in many ways. We’re your franchise attorney and partner for the long haul!