If you’re considering purchasing or selling a franchise, it’s relevant to consider what a franchise disclosure document (FDD) is and what it typically contains. An FDD is a document that a franchiser gives a prospective franchisee before the sale of the franchise is complete. Buying a franchise is a complex investment. The FDD simplifies the process by summarizing certain provisions of the franchise agreement, according to the Electronic Code of Federal Regulations. Failure to provide an FDD violates the Federal Trade Commission Act and will likely result in penalty.
The FDD consists of 23 different parts or items. Understanding these parts and their contents can help the franchisee fully understand the terms of the Franchise Agreement. Mutually, a comprehensive understanding of the FDD structure can help any franchisor avoid potential violation under the FTC Rule.
Item 1: The Franchisor and any Parents, Predecessors, and Affiliates
This portion helps establish the background and history of the franchisor, a crucial piece of information for the franchisee to consider before investing. This section gives any potential franchisee the opportunity to research the franchisor’s history. Have they started other businesses in the past? Was there a predecessor to the franchise and what happened to it? Asking questions about the history of a franchise can provide a more complete understanding of the company’s future growth and success.
Item 2: Business Experience
This item specifies the business’ main figureheads, whether it’s the directors, trustees, partners, etc. This portion of the FDD provides a level of transparency, giving the franchisee the ability to further research any of the primary company leaders.
Item 3: Litigation
Item three discloses pending or completed litigation. In this section, litigation both filed against and filed by the franchisor is revealed. This is among the key sections of the FDD, as it gives the prospective franchisee an idea of the franchisee/franchisor relationship they would be joining. The franchisee should consider whether the franchisor is involved in many suits against franchisees. As the franchisor, it is also vital that the franchisee be provided with any necessary explanations regarding the disclosed litigation.
Item 4: Bankruptcy
Item four of the FDD gives potential franchisees information regarding the financial situation of the franchisor. In this portion of the document, franchisors are required to disclose the company’s bankruptcies within the past ten years. However, within this section, the franchisor has the liberty to describe the bankruptcy and situation as they wish. They may provide as much or as little context as they see necessary.
Item 5: Initial Fees
This is the section where potential franchisees are given an idea of the fees associated with purchase of their desired franchise. Within Item 5, franchisors are also expected provide a range of fees, as opposed to a flat, fixed fee amount. Item 5 should be reviewed carefully in order to ensure an accurate understanding of the investment.
Item 6: Other Fees
Here the franchisor points out which fees are and are not refundable. Whether it’s royalties, advertising fees or transfer fees, it is up to the franchisor to decide which of these are refundable to the franchisee. Furthermore, the franchisor must include any additional funds that the franchisee may encounter.
Item 7: Estimated Initial Investment
This item usually consists of a table outlining the expenses a potential franchisee can expect to pay. These include utility deposits, licenses, or merchandise. Ultimately, this table should be exhaustive and detailed, while maintaining an easy-to-read structure. Franchisees should study this section carefully, especially in the process of creating their own business plan.
Item 8: Restrictions on Sources of Products and Services
Item 8 outlines the franchisor’s relationship with suppliers. While this section may not be totally applicable to all industries, this item gives franchisees an idea of where their products come from. Particularly in the food industry, this item can be used to compare suppliers across franchises. Perhaps a different food franchise has a better supplier and is paying a better price for the products. Additionally, an analysis of the suppliers can help the franchisee maintain quality of product.
Item 9: Franchisee’s Obligations
Here, the franchisee can get an idea of what their job would entail should they purchase the franchise. Again, typically this information is displayed in a table, listing the different responsibilities involved with running the business. Often, this section also references others, creating connections or links between different items of the FDD.
Item 10: Financing
In this section, the franchisor discloses any financing they may offer to the franchisee. Sometimes the franchisor may offer financing plans or packages, however, some do not.
Item 11: Franchisor’s Assistance, Advertising, Computer Systems, and Training
Item 11 is among the longest sections in the FDD, as it tells the franchisee exactly what to expect when it comes to assistance or training from the franchisor. Franchisees are provided with, typically, diligent training programs, ensuring that they feel prepared for the job ahead. Any potential franchisees should also consider whether an extensive training program is something that they can feasibly complete given other life responsibilities.
Item 12: Territory
This section explains what protected territory the franchisee will receive. Item 12 greatly varies from franchise to franchise, depending on company specifics.
Item 13: Trademarks
With the purchase of a franchise comes the right to use company trademarks. For many franchisees, the right to use a popular trademark is an attractive feature of the franchising business model. This section of the FDD explains what the company’s different trademarks are and how they can be used.
Item 14: Patents, Copyrights, and Proprietary Information
Much like the previous item, this part of the FDD discloses any pending or current patents, copyrights, or other relevant proprietary information for the franchisee.
Item 15: Obligations to Participate in the Actual Operations of the Franchise Business
While Item 9 breaks down the franchisee’s responsibilities in a table form, Item 15 provides a more specific explanation of what these responsibilities entail. The responsibilities of a franchisee can be extensive and complex so a simple list doesn’t quite cut it. A careful review of Item 15 can give the franchisee an idea of what the real day-to-day of owning a franchise will look like. Often, but not always, these obligations are laid out in an easy-to-follow table, which the franchisee may review.
Item 16: Restrictions on what the Franchisee May Sell
Here, the franchisee can see a breakdown on what they may and may not sell. Typically, this pertains to the goods or services offered by the franchise. Here, the franchisor may include any limitations on the products that the franchisee may sell. Often, the franchisor also specifies whether or not the franchisee must purchase products from preapproved suppliers.
Item 17: Exit Strategies and Dispute Resolution Procedures
Item 17 is another vital portion of the FDD. Here, the franchisee can find any restrictions related to the termination or transfer of the Franchise Agreement. Here also, the franchisor is obligated to disclose the methods used to resolve legal dispute. Some franchisors prefer to settle disputes through arbitration, rather than the court system. The franchisor’s preferred method of dispute resolution is good to know, as it can help a franchisee prepare for any future issues.
Item 18: Public Figures
Item 18 discloses any public figures that may be involved with the franchise. If the franchise sale is associated with any public figures, the franchisor must disclose any benefits given to the person, any roles or duties they have in business management, and how much the public figure has invested.
Item 19: Financial Performance Representations
The FTC Rule specifies that the Financial Performance Representation (FPR) must be a reasonable representation of the financial performance of the company. Franchisors must be able to provide the resources and data used to comprise their FPR upon request. They must also be explicit in warning franchisees that the report is not a guaranteed report of projected performance.
Item 20: Outlets and Franchisee Information
This section of the FDD provides a table outline of all the company’s franchised locations from the previous three years. These tables often outline state-by-state locations and compare the number of outlines at the beginning of the year to the end of the year. This item of the FDD gives any prospective franchisee a good idea of the size and success of their desired franchise.
Item 21: Financial Statements
Franchisors are expected to include audited financial statements for the prospective franchisee’s review. While start-up franchisors likely can not provide the required audited statements, they are expected to provide other documents, including unaudited opening balance sheets and second fiscal year selling franchises. As soon as the required audited statements are available for preparation, the franchisor is expected to do so.
Item 22: Contracts
All agreements and contracts that the potential franchisee is expected to sign is are provided in this section of the document. Here, franchisors include the franchise agreement, non-disclosure agreements, and any other applicable contracts.
Item 23: Receipts
The receipts in this section verify that the prospective franchisee received the franchise disclosure document.