The Franchise Disclosure Document (FDD) is a treasure trove of information for anyone serious about examining a franchise opportunity. It contains all of the information that state and federal franchise regulators consider relevant to a franchise investment, and it is indispensible to a franchise purchaser. Information in the FDD ranges from the history of the franchisor and the business experience of its executives, to the fees that the company charges, to the requirements for purchasing inventory, to the form of franchise agreement, to three years of the franchisor’s financial statements.
Some portions of the FDD are more interesting, more useful, more practical, and more insightful than others. If you could use only one section of the FDD in evaluating a franchise program, what would it be? What should you consider the most valuable information in the FDD?
The finest treasure in the entire document is not the franchisor’s litigation history or the estimate of the franchisee’s total expenses. It’s not even the financial performance representations in Item 19.
Without question, the most valuable part of the document is Item 20: “Outlets and Franchisee Information.” This section summarizes much of the information about the franchise system. To understand why it is so valuable to your research, you should understand exactly what information the franchisor is required to disclose in Item 20.
Tables: Item 20 contains five tables, each statistically summarizing some aspect of the franchisor’s national system. Table #1 summarizes the franchisee and company-owned information that is detailed in Tables #3 and #4, so that an overall picture of the national system emerges. The tables break down into state-specific numbers over the last three fiscal years. With a glance you can see whether there are increasing or decreasing numbers of franchises in your state over those years, as well as the national picture.
Lists: The FDD contains two lists: the addresses and telephone numbers of operating franchisees as of the end of the last fiscal year, for most companies that will be December 31. The rules do not require that the franchisor include every franchisee in the system. The FDD must have a list of all the franchisees in your state and adjacent states up to 100 franchisees, although for most FDDs you will find a complete national list of franchisees. The second list has limited contact information for those franchisees, if any, who left the franchise system for any reason in the past fiscal year.
The lists are absolute gold. You owe it to yourself and to the wisdom of your investment to contact a fair sampling of existing franchisees, and as many of the departed franchisees as you can. You can explore some of the basic questions about the franchise:
- “How good is the company’s training program?”
- “Do you enjoy the franchised business? Tell me about a typical day.”
- “What’s the toughest part of the business? The most enjoyable?”
- “Can you tell me your unit’s revenues from last year?” (This is your most important question. Franchisees may be your best and only source of financial performance information. Some franchisees may consider this information confidential, but most will talk with you about the money side of their businesses. Show sensitivity when asking these questions. You may want to assure the franchisee that you will use the data for your own planning purposes and will not share it with others.)
- “If you had a chance to do it over, would you purchase the franchise?”
The final gems in the Item 20 information are disclosures about franchisee associations in the system and contractual limitations on franchisees. If one or more franchisee associations exist, you will find contact information at the end of Item 20. An association may provide a unique perspective on the franchise system and the investment you are considering. Be sure to contact them.
Finally, Item 20 will reveal whether the franchisor has entered into any settlement agreements or other contracts that restrict the franchisees’ freedom to discuss their experience with this franchise system.
Sure, read the entire FDD, but if you can walk away with only one section, take Item 20.
Andrew Caffey is one of the nation’s leading franchise legal specialists; 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 is a frequent speaker and author on subjects of franchise and business opportunity regulation.