When buying a franchise, it is important to review the franchise disclosure document (FDD) in its entirety. Each of the FDD’s 23 “Items” contain information that is relevant to prospective franchisees’ buying decisions. But, as with most legal documents, certain provisions are potentially more impactful than others, and franchise buyers will want to pay particular attention to these provisions during their due diligence. In this article, franchisee attorney Jeffrey M. Goldstein highlights seven “can’t miss” provisions of the FDD.
7 Key FDD Disclosures for Prospective Franchisees
To be clear, these are by no means the only “can’t miss” provisions of the FDD—just some important examples. When evaluating franchise opportunities, prospective franchisees should pay particular attention to provisions including:
1. Litigation and Bankruptcy
These are actually two separate provisions of the FDD (in Items 3 and 4), but they go together. Most FDDs will contain “negative disclosures” regarding litigation and bankruptcy—meaning that the franchisor doesn’t have anything to disclose. But, if Item 3 or Item 4 contains an affirmative disclosure, it will be important to carefully assess what impact (if any) this has on the viability of the franchise opportunity.
Item 6 of the FDD should list the ongoing and one-time fees franchisees are required to pay after they sign the franchise agreement (the initial franchise fee appears in Item 5). Prospective franchisees should review these fees carefully, as they can drastically impact both the profitability of a franchise and the feasibility of certain acts (such as seeking renewal).
3. Estimated Initial Investment
While prospective franchisees should carefully review the franchisor’s estimated initial investment in Item 7, they should take the franchisor’s estimates with a grain of salt. The categories of expenses in Item 7 are usually a good starting point, but franchise buyers will need to independently assess their own startup costs and needs for financial reserves.
4. Territory Rights
Territory rights vary widely between franchise systems. Item 12 of the FDD should explain whether a franchisor offers protected or exclusive territory rights (if it offers any territory rights at all).
5. Financial Performance Representations
Item 19 is another place where many franchisors make negative disclosures. But, in this case, it is by choice. A negative disclosure in Item 19 isn’t necessarily a bad sign; however, if a franchisor makes an affirmative Item 19 disclosure, this can potentially be a valuable source of information for prospective franchisees.
6. Outlets and Franchisee Information
The tables in Item 20 are another valuable source of information, and all franchisors are required to complete these tables when preparing their FDDs. Learn how to get the most out of the Item 20 disclosure tables.
7. Franchisor Financial Statements
Franchisors must disclose their financial statements in Item 21. As with the other FDD provisions discussed above, taking the time to review a franchisor’s financial statements carefully can provide valuable insights into the risks associated with a particular franchise.
Considering a Franchise? Talk to Franchisee Attorney Jeffrey M. Goldstein
Are you considering a franchise? We provide four tiers of fixed-fee FDD and franchise agreement review programs for prospective franchisees. To discuss your options with franchisee attorney Jeffrey M. Goldstein in confidence, please call 202-293-3947 or request a free consultation online today.