Learn About the Key Aspects of Franchise Disclosure Documents (FDDs) for Prospective Franchisees
When you inquire with a franchisor about buying a franchise, the franchisor will ask you to fill out an application. Shortly after, you will most likely receive a copy of the franchisor’s Franchise Disclosure Document (FDD). This is a formal legal document that is federally required, and it provides (or should provide) critical information about the franchise offering.
All prospective franchisees need to conduct thorough FDD reviews. If you are thinking about buying a franchise, you need to review the FDD in its entirety, taking notes and preparing a list of questions as you go. If you are still interested in the franchise opportunity after reviewing the FDD, then the next step is to speak with a franchise attorney who can answer your questions and provide additional insight into the risks of franchise ownership.
The 5 Core Components of an FDD
While Franchise Disclosure Documents are complex documents that can seem overwhelming at first, a typical FDD will have five core components. Focusing on each of these components one-by-one can help make conducting FDD reviews more manageable for prospective franchisees. As you’ll see below, reviewing some of the components of an FDD will take more time than reviewing others:
1. The Table of Contents
After the cover pages of an FDD, you will find its table of contents. It’s worth spending some time with the table of contents, because this will give you an understanding of what you can expect during the remainder of your review. As you will see, the main portion of the FDD consists of 23 “Items”, followed by a series of exhibits and addenda.
Under the Federal Trade Commission’s (FTC) Franchise Rule, all FDDs must contain the same 23 Items. The Franchise Rule establishes specific disclosure requirements for each Item, as one of the Franchise Rule’s primary goals is to make it easy for prospective franchisees to compare franchise opportunities. With that said, if you review two (or more) FDDs, while you will see structural similarities, the substance will almost certainly be very different. This is why a thorough FDD review is critical for each franchise opportunity you are seriously considering.
2. The 23 Items
After the Table of Contents, you will find the 23 Items of the FDD. You should read all 23 Items carefully during your review. While some Items will be more interesting than others, they all contain information that is relevant to your franchise buying decision. The 23 Items of the FDD are:
Item 1: The Franchisor and Any Parents, Predecessors and Affiliates
Item 2: Business Experience
Item 3: Litigation
Item 4: Bankruptcy
Item 5: Initial Fees
Item 6: Other Fees
Item 7: Estimated Initial Investment
Item 8: Restrictions on Sources of Products and Services
Item 9: Franchisee’s Obligations
Item 10: Financing
Item 11: Franchisor’s Assistance, Advertising, Computer Systems and Training
Item 12: Territory
Item 13: Trademarks
Item 14: Patents, Copyrights and Proprietary Information
Item 15: Obligation to Participate in the Actual Operation of the Franchise Business
Item 16: Restrictions on What the Franchisee May Sell
Item 17: Renewal, Termination, Transfer and Dispute Resolution
Item 18: Public Figures
Item 19: Financial Performance Representations
Item 20: Outlets and Franchisee Information
Item 21: Financial Statements
Item 22: Contracts
Item 23: Receipts
Broadly speaking, the FDD’s 23 Items contain information about the franchisor’s business, the franchise system, and the legal and financial aspects of the franchise opportunity. All of these are relevant to franchisees’ buying decisions, and they all require equal consideration. For additional insight into what you can (and should) get out of each of the FDD’s 23 Items, you can read our three-part series on conducting FDD reviews:
- Understanding Your Franchisor’s FDD – Part 1
- Understanding Your Franchisor’s FDD – Part 2
- Understanding Your Franchisor’s FDD – Part 3
3. The Receipt Pages
The Receipt pages for the FDD appear in Item 23. You will most likely be asked to sign two copies—one for you and one for the franchisor. While the Receipt pages are fairly straightforward, they contain one key disclosure:
“If [the franchisor] offers you a franchise, it must provide this disclosure document to you 14 calendar days before you sign a binding agreement with, or make a payment to, the franchisor or an affiliate in connection with the proposed franchise sale. If [the franchisor] does not deliver this disclosure document on time or if it contains a false or misleading statement, or a material omission, a violation of federal law and state law may have occurred . . . .”
As this states, by law, you must receive the FDD at least 14 calendar days before you sign a franchise agreement or pay an initial franchise fee. This 14-day window is known as a “cooling off” period. It is intended to ensure that prospective franchisees are not pressured into buying a franchise, and that they have the time they need to thoroughly review the FDD and seek legal advice so that they can make an informed buying decision.
4. The Exhibits
After the FDD’s 23 Items, you will find a series of exhibits. While there are several types of exhibits that franchisors may choose to include in their FDDs, there are two exhibits in particular that will require a careful review:
The Franchisor’s “Form” Franchise Agreement – One exhibit to the FDD will be the franchisor’s “form” franchise agreement. Although this should be identical to the franchise agreement you are asked to sign, this is something you will need to confirm. While the FDD is a disclosure document, the franchise agreement is a binding contract that will govern your relationship with your franchisor. As a result, thoroughly reviewing the franchise agreement is just as important as reviewing the FDD’s 23 Items.
The Franchisor’s Financial Statements – Even though Item 21 of the FDD is labeled, “Financial Statements,” franchisors will typically include their financial statements as an exhibit to the FDD. As a general rule, franchisors must include their audited financial statements for the past three years. However, new franchisors are permitted to follow a “phase-in” approach. Understanding the franchisor’s financial condition is extremely important; so, if you are not comfortable examining financial statements yourself, you may want to have them reviewed by a financial professional.
As part of the FDD review process, your franchise attorney can review your franchise agreement as well. This part of the review will include noting any provisions of the franchise agreement that are particularly high-risk and may warrant negotiation. It is important not to become emotionally invested in a franchise opportunity too soon, as there are various issues that require careful, unbiased and practical consideration.
5. The State-Specific Addenda
Finally, FDDs will typically include various state-specific addenda. In addition to the FTC’s Franchise Rule, some states have adopted laws that require franchise-related disclosures as well. If your state has a franchise disclosure law, then the FDD should have a state-specific addendum to match, unless the franchisor has included the state-specific disclosures in the main body of the FDD.
Hiring a Franchise Attorney to Conduct an FDD Review
So far, we’ve been talking about what prospective franchisees need to know when conducting FDD reviews. But, while it is critical that you review the FDD yourself, it is also critical that you hire an experienced attorney to conduct an FDD review for you.
Why? First, an attorney who has decades of experience reviewing FDDs and helping franchisees resolve franchise-related disputes will have an intimate understanding of the FDD’s most important disclosures. As a result, he or she will be able to provide insights that most prospective franchisees will not be able to glean on their own. Among other steps, your attorney will thoroughly review key areas of the FDD to ensure that you are aware of any issues that you should consider before making your buying decision.
Second, an attorney who is experienced in reviewing Franchise Disclosure Documents will be able to tell you if any mandatory information is missing from your chosen franchisor’s FDD. Knowing what is missing from an FDD can be just as important as understanding what’s in it. If your FDD is missing required disclosures, this itself could be a red flag that requires careful consideration.
Third, your attorney will be able to answer all of the questions that arise during your review of the FDD. When buying a franchise, it is important not to leave any questions unanswered. Buying a franchise is a long-term (and potentially high-risk) investment, so it is critical to ensure that you gather as much information as possible before you move forward.
Contact Us for a Free Consultation Today
Are you thinking about buying a franchise? If you have received a Franchise Disclosure Document for a franchise opportunity that you are seriously considering, we encourage you to contact us for more information about our FDD reviews. To schedule a free, no-obligation consultation at Goldstein Law Firm, please call 202-293-3947 or tell us how we can help online today.
