A breakdown of how to read, where to focus, and help on how best to use a franchisor's Franchise Disclosure Document (FDD).
So, you're ready to start a business, but the idea of doing it from scratch seems daunting. Franchises offer a compelling alternative, they give you structure, support, a proven business model, and brand recognition. But before you jump in, there's a crucial document you need to understand: the Franchise Disclosure Document (FDD).
Think of the FDD as your roadmap to franchise ownership. It's a legally mandated document that discloses everything a potential franchisee should know about the franchisor and the franchise system — that being said, no two are alike so reading and assessing their information takes work. This article will help you understand this key document with quick tips on where to focus and how to use your franchisor's Franchise Disclosure Document (FDD).
Demystifying the FDD
The FDD is a standardized(-ish) document mandated by the Federal Trade Commission (FTC). This means it follows a specific format, with 23 required items. Here's a breakdown of some key sections to pay close attention to:
Franchisor's Background (Items 1-4): This section dives into the franchisor's history, including its experience, leadership team, and any past legal or financial issues like bankruptcies or lawsuits. Look for outstanding lawsuits and cross-reference them with Google searches to see if anything negative has surfaced in the news. A lot of your favorite franchises have grown a bit too fast and not paid attention to their franchisee’s needs, this section will help you assess that. Look for closed and transfer numbers. Transfers are a way to hide poor-performing franchises by moving them over to a trusted franchise owner.
Costs and Investment (Items 5-9): Here's where you get real about the money. This section details all the fees associated with the franchise, from the initial franchise fee to ongoing royalties and marketing contributions. It also estimates the initial investment required to get your franchise up and running. This is usually a snapshot of start-up and first 3 months of operation. Most franchisors will provide you with a Profit & Loss (P&L) model, also called a unit economics model, or financial model. They will walk you through how to start adding the numbers. Check the details, like for listed equipment costs is it the full cost of buying the equipment outright, or are they using 3 months of lease payments? Don't just rely on the FDD figures. Validate these costs with existing franchisees. Ask them about any additional expenses they encountered that weren't listed. To get a sense of real estate costs in your target area, look for listings on LoopNet. Use sites like Glassdoor and Indeed to research employee compensation in your area. Look at similar businesses to know how much you can charge.
The Franchise Agreement (Item 22): This is the legal contract between you and the franchisor. It outlines your rights and responsibilities, territory restrictions, training provided, and renewal terms. Scrutinize this section carefully, paying particular attention to royalties, marketing fees, and any other potential hidden fees. Consider consulting with a franchise attorney to ensure you understand all the implications. Look over the non-compete and customer ownership sections. Look at renewal options, do you have to pay a full franchise fee at the end of your term or is it a small renewal?
Financial Performance (Item 19): Take your time in this section. Franchises cannot guarantee your earnings, but some may include financial information about existing franchisees. It is not always easy to understand where the numbers are coming from, they will not always include all their franchisees. But this will give you a good idea of what to expect for top-line revenue. Most franchisors want to look good but won't overpromise. The key here is comparison. Look at FDDs from similar franchises to see what kind of financial data is typically included, and what information this particular franchisor might be leaving out or including. If they overshare that is a great sign of confidence. If you don’t have other FDDs, you can always go to the Wisconsin Franchise Investment Registry and find most FDDs.
Existing Franchisees (Item 20): The FDD should provide contact information for a sample of existing franchisees. Reach out to them! Their firsthand experiences can offer valuable insights into the day-to- day realities of running the franchise. Make sure to call at least 6 franchisees, with 10 calls being ideal for a more comprehensive picture. Focus on owners in territories similar to yours. Prepare a list of questions beforehand and take detailed notes during your conversations. Tips to getting people to return your emails or calls. Use the word “Validation Call” in subject lines. If phone numbers are included go ahead and text them, these are usually cell phones.
Beyond the Basics: Critical Thinking
While the FDD provides a wealth of information, it's really all about how you analyze and use the information. Here are some additional tips:
Build a business plan: Even if it's just a basic 10-minute one, it is crucial. This will help you structure your analysis and pinpoint areas where you need to gather more information. I like this Business Plan template from Shopify.
Do Your Research: Reach out to existing owners, go into locations, have friends and family use the service. Investigate the franchisor's reputation online and within industry publications. Listen to Podcasts, some of my favorites include: The How of Business, Acquiring Minds, Franchise Empires
Seek Professional Help: Use a broker — it’s free to you and having a partner that can help guide you makes the process a lot easier. Not to mention, they can have a rolodex of franchise lawyers, tax strategists, and more. Consult with a franchise attorney and a financial advisor to review the FDD and your financial situation.
By thoroughly reading and analyzing the FDD, using a structure like a business plan, conducting comprehensive research, and consulting with professionals, you'll gain a deeper understanding of the franchise opportunity that will give you confidence in making an informed decision about your future. When I start to second guess myself it helps to know that I did everything I could to make an informed decision and my anxiety disappears (kind of). Remember, the FDD is your key to unlocking the potential of franchise ownership, so take your time, ask questions, and proceed with caution.
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