Prospective franchisees report that they when they read Franchise Disclosure Documents (FDDs), they are often seized with a condition called MEGO—“My Eyes Glaze Over.” It’s understandable given the amount of information in these documents—and if you have several FDDs to compare, the process can be daunting.
I recommend that anyone comparing disclosure documents take advantage of a hidden feature all FDDs share: the fact that they are all answering one rigid set of questions. When we franchisor attorneys sit down to write a disclosure document, we have at hand a copy of the Amended FTC Rule, the FTC’s Compliance Guide, a set of FAQs (frequently asked questions) provided by the FTC, and for good measure the North American Securities Administrators Association Inc. (NASAA) 2008 Franchise Registration and Disclosure Guidelines. Taken together, these weighty volumes of dry bureaucratic prose explain in exacting detail how a disclosure document is to be written and presented. I can tell you that there is very little wiggle room left for creativity when it comes to drafting a franchise disclosure document. In fact, the requirements of the disclosure format are as exacting as they are precisely in order to give prospective franchisees grounds for a useful comparison between offerings.
How do you take advantage of this behind-the-scenes info? It actually sets up an easy way to compare offerings. If you look at key areas of the FDD, you will be able to focus in on an apples-to-apples comparison.
Franchisor Litigation and Bankruptcy. Every franchisor must reveal the same material litigation and bankruptcy information over the last 10 years. The definitions are exacting.
Fees. Item 5 must detail all payments to be made to the franchisor before the franchisee can open for business. This Item may include no more than the initial franchise fee, but if there are any training fees or software fees required early on, you will find them here. Item 6 must present in a table all other fees payable to the franchisor during the term of the franchise. These make fee comparisons easy.
Investment. The ultimate in apples-to-apples is an Item 7 summary table that details a definitive range of investment expenses, answering the question: “Which offering is more expensive?” (Tip: make sure real estate expenses are treated the same way. Sometimes they’re excluded from the estimates.)
Territory. Comparing territory in apples-to-apples fashion is not quite as straightforward. The FDD at Item 12 will describe your territory rights, and will give you the dimensions of a minimum territory. The balance of the Item will discuss your rights inside and outside the territory, and how Internet marketing or other technological developments might affect those rights.
Trademark. Don’t slide past Item 13 (“Trademarks”) too fast. You should confirm that the primary trademark is federally registered. If it is, you will see a “Registration” number and the date of registration. If it is merely “pending” with the feds you will see a “Serial Number.” Federal registration on the Principal Register is an important part of the trademark rights you will be granted. You can confirm the status of the registration yourself at www.uspto.gov using the Trademark Electronic Search System (“TESS”).
Obligations. Franchisee obligations are presented in table form at Item 17, and they are all broken down into the same categories for easy side-by-side comparisons.
Financial Performance Representations. Franchisors have wide latitude regarding the types of information they can show in Item 19 (see [link]), so don’t expect an easy comparison here.
System Stats. The five (or more) tables required in Item 20 will give you an instant picture of the expansion or contraction of the systems you are comparing over the past three years, as well as the projected growth in the year to come. Comparison should be a matter of doing some math.
Financials. Every disclosure document contains financial information about the franchisor in an exhibit. Look at those statements for a side-by-side comparison. Audit standards in the accounting profession result in a very similar structure in the financial statements, making a comparison possible even if you are not a CPA. (Of course, if you are seriously considering the investment, you will want to have an accountant review the financials in detail.)
The structure of the FDD actually lends itself to ease of comparison between two or more franchise systems. On several key points you can compare information provided in response to the same question, the same table, or the same checklist of required information.
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.