3 Awkward Questions You Must Ask a Franchisor
The Franchise Disclosure Document certainly delivers a lot of information, and without doubt it is the place to start when considering buying a franchise. But the FDD you receive is not the end of the story, and it is not likely to reveal the franchisor’s whole story. The limited disclosure requirements and the overlap of federal and state law, by design or not, allow franchisors to sidestep important disclosures mandated by individual states and to shield key parts of their regulatory life from one state to the next.
The message here will be surprising to many franchise investors: You cannot assume that the FDD you receive contains the same information as FDDs distributed in other states.
With this behind-the-scenes fact in mind, here are three questions you should ask about a franchise that I guarantee you the franchisor will not be comfortable answering.
Awkward Question #1: “What is the average profitability of your units?” As with all questions about the performance of the franchise, franchisors may elect not to make performance information available. Due to the different standards and demands of individual registration states (California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Rhode Island, South Dakota, Virginia, Washington state, and Wisconsin), a franchisor may decide to include performance information in some states and not others.
If financial performance information is not in the FDD’s Item 19, all franchisors following the law will simply decline to answer; instead, they may refer you to their existing franchisees. The company is not required to provide performance information if it chooses not to – even if it provides that information in other states.
If the company includes an Item 19 “Financial Performance Representation” in the FDD, it will probably restrict its answer to the four corners of the disclosure. If the disclosure presents revenue figures, but not profitability analysis, you will have a difficult time getting your question answered by the franchisor.
Awkward Question #2: “Has any franchise registration state rejected the company’s franchise offering or found that it poses a risk to investors?” If a franchise registration state finds that an unreasonable risk is posed by an offering, it may require that the company protect investors by posting a bond, putting franchise fees in an escrow account, or delaying collecting initial franchise fees until the franchisee is open for business, and you (in another state) would not know anything about it from your FDD.
There is no legal reason that a franchisor cannot answer this question if it chooses to, so don’t accept a razzle-dazzle “We can’t legally comment on other state registrations” answer. If another state thinks that franchisees need additional financial protection, you should know about it. Maybe you could benefit from a similar protective arrangement.
A good question in the same category: “Do you include any Cover Page Risk Factors on an FDD registered in another state that do not appear on the FDD used in my state, and may I see them?”
Awkward Question #3: “How many of the franchisees who are listed in the FDD as having left the system last year actually failed in their franchised businesses?” Failures in a franchising system are not easy to spot in the FDD. You will receive in the FDD a list of franchisees who left the system for any reason in the prior fiscal year, and you can call them, but just reading the FDD you will not be able to tell whether their departure was due to retirement after 18 years of successful operation, a business failure after one year, a transfer, an illness, or a divorce.
Even the Item 20 statistics reveal only the bare bones: If some units were “terminated,” “not renewed,” or “reacquired by Franchisor,” there is no clue offered regarding the reasons for the termination, nonrenewal, or reacquisition, and how the owners fared in the situation. Obviously, franchisors do not want to talk about their failure rates, but it would be very useful information.
The state franchise registration process is largely hidden to the investor. If you live in a non-registration state, you will probably receive exactly the same FDD delivered to all other non-registration states, but no matter what state you live in, it is well worth probing what changes – and additional nuggets of information – may have resulted from the state registration process…even if the franchisor doesn’t want to talk about it.
Andrew Caffey is one of the nation’s leading franchise legal specialists and he represents franchisors across the United States. Caffey served as General Counsel of the International Franchise Association, a member of the Governing Committee of the ABA Forum on Franchising, and Chair of the ABA Forum on Franchising. He also is a member of the bar in Maryland and the District of Columbia, and a member of the Panel of Neutrals of the American Arbitration Association. Caffey has appeared on numerous franchise programs and is a frequent speaker and author on subjects of franchise and business opportunity regulation.
