"Getting the facts on that franchise you want."
The franchise industry is very regulated - and that is a good thing! If you do the proper due diligence and talk to enough existing owners you will make an informed decision. The FDD is part of that process.
The Franchise Disclosure Document (referred to as the FDD or disclosure document and formerly called the UFOC) is the document that a franchise company is required by law to give to a prospective franchise buyer before the franchise can be purchased, and includes a wealth of information about the franchise, including:
- The history of the franchise and its officers and directors.
- A complete description of the business to be franchised.
- All costs and fees that you will be subject to under the agreement.
- All obligations of either party to the other during the term of the agreement and thereafter.
- Any relevant litigation history of the company or its officers.
- Any business failures, ownership transfers, franchise agreement terminations or other potentially adverse information relating to the success rate of the existing units in the system.
- Audited financial statements for the previous three years for the franchise company.
- A list of the existing franchisees.
- A complete copy of the actual franchise agreement document is usually attached to the FDD but may be provided under separate cover at the option of the franchisor.
As you read the offering circular it will be helpful for you to read it from the “inside out”. This means that you should read it as if you already were a franchise owner. You undoubtedly will find a few clauses that seem very restrictive. However, remember that the franchise company needs to protect the quality and integrity of its entire system. For example, a restaurant franchise may have a clause that allows the franchise company to make unscheduled inspections and “tag” offenses involving restaurant cleanliness or food quality. A franchise owner may have only twenty-four hours to fix these violations. Sound harsh? What if you were a franchise owner in the territory adjacent to the transgressor, and you kept hearing complaints about how the other restaurant always was dirty, or the food quality was poor. Wouldn’t you want that franchise owner to “clean up his act?” Wouldn’t you feel that the franchise company had an obligation to protect its image—thus protecting your investment? That is why it is beneficial to you to read the FDD “from the inside out”. You will have a better understanding of what systems and policies are in place to protect you.
We recommend you read the entire FDD and all its exhibits thoroughly one time to gain a general knowledge about how it reads and what it contains. After the first reading, read the offering circular a second time. This time, write down any questions or concerns you might have. Feel free to write in the offering circular; it’s your copy. Many have found it helpful to write their questions on Post-It® notes and stick the notes directly on the pages to flag the paragraphs in question. Then, when you discuss the FDD with your franchise company representative you will be fully prepared.
Some of the franchise companies may include an earnings claim and now called a “financial performance representation” in their FDD document. It’s very convenient for you when they do, but it is still important that you discuss performance of a franchise system when you conduct your own validation calls or visits with owners later in this process.
Here are some of the elements of a FDD, and what they cover:
Items 1 through 4: The franchisor’s background, the experience of key executives and the company’s litigation and bankruptcy history
Items 5 and 6: All the fees charged by the franchisor
Item 7: An estimate of the total investment needed to establish the business
Item 8: Restrictions on the purchase of products to be used and sold in the unit
Item 9: The franchisee’s obligations
Item 10: Financing that the franchisor makes available
Item 11: A summary of the services, such as training and site selection that the franchisor provides in relation to the franchise program
Item 12: Territorial protections
Items 13 and 14: The status of the trademarks, copyrights and patents associated with the program
Item 15: Obligations of the franchisee to participate in the actual operation of the franchised business
Item 16: Restrictions on what the franchisee can sell
Item 17: Renewal, termination, transfer and dispute resolution provisions
Item 18: Public figures used to promote the franchise
Item 19: A description of how well the franchises perform financially
Item 20: System statistics and lists of franchisees and former franchisees
Learn more about the author, Phyllis Pieri, CFE.
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