FDD Analysis

FDDs are usually written for the average person to be able to read and understand. However, prospective franchisees are always advised to hire a franchise attorney to do a more thorough job of reviewing the FDD. A professional review usually costs from $200 to $500.

Please refer to FranchiseDisclosures.com for information on how you can obtain a franchisor's FDD for reviewing and how to obtain the service of a franchise attorney.

We include a brief breakdown here of the FDD's various parts:

1. The Franchisor, Its Predecessors, and Affiliates

In this section, you'll learn the names of the franchisor, its predecessors and affiliates, as well as the type of business entity the franchisor is, i.e. a corporation, partnership, etc. You also find out the length of time the franchisor has operated the franchise you are interested in, as well as whether or not the franchisor has offered franchises in other lines of business. Finally, the franchisor describes regulations specific to its industry.

2. Business Experience

You are given the occupation and experience of the franchisor's directors, trustees or general partners, principal offers, and other executives for the past five years.

3. Litigation

This contains the legal history of the franchisor and its associated people for the past ten years. Be aware of lawsuits the franchisor has been involved in for charges such as the violation of franchise law, fraud, unfair business practices, or misconduct of some kind. If such an action is pending or if the franchisor is subject to an injunction, the FDD must provide information in detail. We also advise you to look beyond the FDD and examine the court files, which are open to the public. You can also call the opposing side for a different perspective.

4. Bankruptcy

This section states whether or not the franchisor or its officers have gone through bankruptcy or been reorganized due to insolvency during the past ten years. If any of the officers were also associated with a company that went bankrupt or was reorganized due to insolvency within one year after that association began, that must be disclosed.

5. Initial Franchise Fee

This is the amount you must pay even before you start operating your business. The section should also inform you of whether the payment is payable in installments or in a lump sum, as well as whether or not the fee is refundable and under what conditions. Sometimes, the franchisor may also charge initial fees that vary from franchisee to franchisee, so be aware of how these fees are determined.

6. Other Fees

Franchisors usually use a chart format to detail various fees and conditions for refunds. There is also information on voting power, as represented by a cooperative organization of franchisees or by franchisor-owned outlets.

7. Initial Investment

Again using a chart format, the franchisor lists estimates (providing a range of low- and high-end numbers) of expenses you are expected to incur in preparation for the opening of your business. Other information includes the party to whom the payments are made to, when the payments are due, and the conditions for refunds. If the franchisor provides financing for any portion of your initial investment, interest rates and other details should be provided.

Expenses may include the following:

• Real estate (be careful: many franchisors exclude these real estate expenses from their tables because there is such a huge variance in real estate costs from location to location; however, they will usually include estimates in accompanying footnotes)
• Equipment, fixtures, leasehold improvements and decorating costs
• Initial inventory
• Security deposits, utility deposits, business licenses, and a minimum of three months' working capital

8. Restrictions on Sources of Products and Services

The franchisor may require you to purchase or lease from it certain goods, services, supplies, fixtures, equipment, inventory, or real estate. If this is the case, the franchisor must disclose if and how it earns income from these restrictions. Some franchisors allow you to buy from outside suppliers, but only if they are on an approved list of vendors.

9. Franchisee's Obligations

It is important to know what is expected out of you so that you hold up to your end of the bargain.

10. Financing

Some franchisors offering financing, the terms and conditions of which should be disclosed here. This section also provides information on your liability if you miss payments. Be aware of whether you are dealing with the franchisor or with a third party in financing arrangements. If you are dealing directly with a franchisor, you may stop payment if the franchisor has failed to meet its obligations to you. If you are dealing with a third party, you must pay regardless.

11. Franchisor's Obligations

The section on franchisor obligations can be broken down into these parts: pre-opening obligations, ongoing support, and training.

Pre-opening obligations may include the following:

• Negotiation of a site lease
• Knowledge of site rules and regulations
• Assistance with obtaining building permits
• Remodeling and decoration of site
• Purchase or leasing of equipment, signs, and supplies
• Staffing and training of employees
• Operations manual
• Training program

Ongoing support may include the following:

• Visits to your store
• Toll-free numbers for franchisee assistance
• Annual conventions
• Company intranet that facilitates franchisee communications
• National advertising support

Training program information may include the following:

• Location, length, and times of the year training programs are held
• Content, both in-store and in-classroom
• Experience of the instructors
• Fees associated with training, including travel and living expenses you may incur
• Availability of additional training programs in the future (these may be mandatory)

12. Territory

Some franchisors offer you exclusive territories, which means the franchisor agrees not to grant other franchises in the area that may compete with you. Do not take exclusive territories at face value. Some are defined narrowly or vaguely. Others require you to attain certain sales numbers to maintain your exclusive rights.

13. Trademarks

Most franchisors require you to use their trademarks or other commercial symbols. Seeing as how these contribute to much of a franchise's value, there should not be a problem. The franchisor will also disclose whether or not the trademarks and symbols are registered with the U.S. Patent and Trademark Office and any significant legal agreements that may affect your usage of these trademarks and symbols.

Make sure the franchisor is responsible for all challenges to the usage of trademarks and symbols (get this in writing!). You should not be obligated to pay for any damage awards, and you should be reimbursed if you have to replace signs and other supplies that use trademarks and symbols by court order.

14. Patents and Copyrights and Proprietary Information

The franchisor must fully disclose all information regarding any patents or copyrights that relate to the franchise, and the terms and conditions that surround their usage. The franchisor must also describe confidential information or trade secrets for which it has claimed proprietary rights.

15. Obligation to Participate in the Actual Operation of the Franchise Business

Franchisors will often allow a franchisee to designate another person to manage the franchise, such that the franchisee is not an active participant in the day-to-day operations of the business. However, some franchisors want the owner to be more involved. In this section, the franchisor will disclose a requirement for the franchisee to operate the franchise personally, or at least a recommendation to do so.

16. Restrictions on What the Franchisee May Sell

If the franchisor restricts your product/service offering, it will disclose details of that restriction here. You may be obligated to provide all of the franchisor's products exclusively. The franchisor may also reserve the right to change the types of goods and services you sell at any given time.

17. Renewal, Termination, Transfer, and Dispute Resolution

In this section, the franchisor spells out under what conditions you have the right to renew, extend, or terminate your franchise. Conversely, the franchisor reveals the conditions under which it may terminate franchise relations with you. Look also for information on whether disputes must go through mediation and arbitration rather than court. Mediation and arbitration proceedings are usually much less expensive and conclude faster as well.

18. Public Figures

Franchisors often use celebrities to promote the business. In this section, the franchisor must describe the nature of the agreement, compensation, and any investment the celebrity has made in the franchisor.

19. Financial Performance Representations

The franchisor can either provide franchisees with actual or potential sales, profits, or earnings of franchisees, or it can provide nothing. Most franchisors choose the latter, because doing the former requires a description of the factual basis and material assumptions that support the claims. However, recent years have seen a large increase in the percentage of franchisors that provide an Item 19.

In order for financial performance representations to reveal meaningful information, you must know the number of franchisees upon which the numbers are based, as well as the number of years they have been operating. You should have an accountant go over the numbers and contact several franchisees to cross-check the information.

20. List of Outlets

In this section, the franchisor uses a table format to list the total number of franchise locations, including both those in current operation and those in franchise agreements but have not yet opened. The number of canceled or terminated franchises, the number of franchises not renewed, and the number of units reacquired by the franchisor within the last three years are also released. All names, addresses, and telephone numbers of franchises in your state are also given. These pieces of information can be valuable if you take action to pursue them.

For systems with under 25 units, talk to all franchisees. For those having between 25 and 100 units, talk to at least half. And for all others, interview a minimum of 50. Make sure you try to select franchisees who have been in the business for at least a year.

Ask franchisees basic questions such as:

• Is it a good business relationship? What kind of support do you receive?
• Would you do it again?
• Are you making a profit? If so, how much and how long did it take to get there?
• Would you recommend putting your life savings into this franchise?

Use good judgment and interpersonal skills when asking franchisees questions. Some may be sensitive to admitting their own personal decision-making mistakes. Still others have an incentive to bring you into the system if the franchisor offers a commission. You should always contact a sufficiently large pool of franchisees for a more reliable assessment.

21. Financial Statements

The franchisor must include audited financial statements to give you a picture of the overall financial health of the company. Again, obtain the assistance of an accountant with franchise experience to interpret the figures and ask questions. Financial strength indicates not only a solid business concept but also a franchisor with the ability to provide you with the support services promised in the FDD. You can usually seek recommendations from successful franchisees for accountants with the necessary background.

22. Contracts

The franchisor provides a copy of all agreements you will be expected to sign if you purchase the franchise, such as lease agreements, option agreements, and purchase agreements. You must read all of them carefully before signing. An attorney's assistance is always recommended and you may find one in our Resource Center.

23. Receipt

To verify that you have received the FDD, you must sign a detachable receipt, which is found on the last page of the FDD.

Next: Franchisor Analysis