Item 20 of the Franchise Disclosure Document (FDD) provides an overview of the status of a franchise system. Its tables disclose the number of active franchises, terminations, non-renewals and closures over the past three years, as well as the number of franchisees who have signed agreements but not yet opened and the franchisor’s projections for the upcoming year. These are all valuable pieces of information, and they allow prospective franchisees to gain some important insights with the help of an experienced franchise lawyer.
Growth, Turnover and Terminations
Three of the most important pieces of information that prospective franchisees can take away from Item 20 are the franchisor’s growth rate, turnover rate and termination rate. These are important for different reasons.
In general, a positive growth rate is a good sign. It suggests that more franchises are opening than closing and that new franchisees are continuing to see value in the franchise system. But, the growth rate alone doesn’t tell the whole story. If a franchise system has a high turnover rate, this may suggest that the franchisor focuses on selling new franchises rather than supporting its existing franchisees. If a franchise system has a high termination rate, this may suggest that the franchisor has little patience for franchisees who are unable to find success or who do not strictly adhere to the franchisor’s standards.
Since Item 20 provides three years’ worth of data, franchisees can also examine a franchisor’s growth, turnover and termination rates over time. If a franchisor’s turnover or termination rate is consistently high (or has increased over the past three years), this may be a bad sign. Conversely, if Item 20 shows steady growth with relatively little turnover (including only a small percentage of terminations, non-renewals, and franchisees who “ceased operations for other reasons”), this may point to a healthy franchise system.
Pending and Projected Franchise Openings
The lists of pending and projected franchise openings in Item 20 can provide prospective franchisees with useful information as well. Prospective franchisees should check whether these lists are consistent with the franchisor’s growth figures for the last three years and inquire regarding any disparities.
If the lists show higher-than-normal numbers, is this because the franchisor is making a push for growth? If so, is it emphasizing growth in certain geographic regions? Or, could this be a sign that a significant percentage of prospects sign franchise agreements but never open for business? These, obviously, are very different situations, and they can provide very different perspectives on the viability of a franchise opportunity.
Of course, Item 20 is just one source of information about franchise opportunities. Prospective franchisees should read the FDD in its entirety, conduct thorough due diligence, and hire a franchise lawyer to review (and potentially negotiate) the franchise agreement.
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