Pursuant to federal regulations and franchise laws in various states around the country, before selling a franchise, the franchisor must provide the potential buyer with a Franchise Disclosure Document (or “FDD”). Each franchisor’s FDD must closely follow a format that includes:
- A Cover Page
- A table of contents
- Specific information broken out into 23 “Items”
- Exhibits (including a copy of the franchisor’s standard franchise agreement)
While understanding your franchise agreement needs to be a top priority, it is also important to critically assess the information contained in Items 1 through 23. In a series of three articles, we will summarize what you can (or should) expect to see when you open up your franchisor’s FDD.
Item 1: The Franchisor and Any Parents, Predecessors and Affiliates
What You’ll Find
Along with general business information (like the franchisor’s name and address), Item 1 must contain: a description of the franchise business, the general market for the franchise system’s products or services, disclosures regarding the franchisor’s franchising history and whether it operates any company-owned outlets, and information about competition and industry-specific laws.
Why You Care
While Item 1 disclosures tend to be pretty general, prospective franchisees can uncover some key information in Item 1. For example, if the franchisor has a prior history in franchising (especially an unsuccessful one) or if the industry has unique legal requirements, this is certainly something you will want to know going into your franchise opportunity.
Item 2: Business Experience
What You’ll Find
A five-year employment and business experience summary for each of the franchisor’s owners, officers, directors, and operations or sales managers.
Why You Care
If you are like most people, part of the reason you are considering a franchise is because you want to benefit from the franchisor’s experience and expertise. Knowing what the franchisor’s officers and key personnel have (or haven’t) done in the past can be important to making an informed decision about whether a particular franchise opportunity is a sound investment.
Item 3: Litigation
What You’ll Find
Disclosures regarding whether the franchisor, any of its related companies or any individual identified in Item 2 is or has been a party to relevant litigation.
Why You Care
Generally speaking, what you want to see in Item 3 is a “negative disclosure” (in other words, the franchisor does not have any relevant litigation to disclose). If a franchisor has litigation disclosures in Item 3, you need to find out more.
Item 4: Bankruptcy
What You’ll Find
Bankruptcy disclosures similar to the litigation disclosures in Item 3.
Why You Care
Similar to litigation disclosures in Item 3, affirmative bankruptcy disclosures in Item 4 are rare. It is critical that your franchisor have financial stability, so you will certainly want to investigate if a franchisor discloses a bankruptcy in Item 4.
Item 5: Initial Fees
What You’ll Find
Disclosure of the initial franchise fee, any other initial fees (“fees and payments, or commitments to pay, for services or goods received from the franchisor or any affiliate before the franchisee’s business opens”) and whether any of the initial fees are refundable.
Why You Care
These are the initial fees you will need to pay to the franchisor. They should be both reasonable and justifiable in light of the opportunity being offered.
Item 6: Other Fees
What You’ll Find
A table that discloses the monthly royalty, advertising fund fee, renewal fees, transfer fees, and any other ongoing or future one-time payments imposed by the franchisor for itself or on behalf of a third party.
Why You Care
Once again, any fees payable to the franchisor should be firmly supported by the value of the franchise opportunity. Also note that any transfer or renewal fees (i) can significantly impair your ability to either get out of or renew your franchise, and (ii) may be negotiable.
Item 7: Estimated Initial Investment
What You’ll Find
A table that discloses training expenses, leasing costs, inventory requirements and any other expenses you are likely to incur before your franchise opens for business.
Why You Care
Like Items 5 and 6, this could probably go without saying. When it comes to investing in a franchise, the amount of your investment is obviously a top priority. Note that some franchisors provide more-detailed (and more-accurate) estimates than others, so you may want to speak with some current franchisees in order to validate your likely initial investment.
Speak with National Franchise Attorney Jeffrey M. Goldstein
Attorney Jeffrey M. Goldstein represents active and prospective franchisees nationwide. If you are considering a franchise opportunity, Mr. Goldstein can assist you in interpreting the franchisor’s FDD. For a fixed-fee franchise review, call the Goldstein Law Firm at (202) 293-3947 or contact us online today.
