Important information before you invest in a franchise.
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Somewhere along the path toward becoming a franchisee, youâll come across a comprehensive document that outlines almost everything you need to know about the business youâre looking to purchase. Itâs called the franchise disclosure document, aka the FDD.
The FDD is a legal disclosure documentârequired by the Federal Trade Commission (FTC)âthat provides comprehensive franchise details, including business model, trademarks, operations, costs, financial performance, and more. It tries to disclose every bit of relevant information that a franchisee needs to know before committing to a purchase.
Think of the FDD as part rulebook, part guidebook, and perhaps even an almanac of sorts for prospective franchise buyers. It tells you what you can and canât do, and how much itâs going to cost. (Hereâs a cost comparison of different franchisesâand tips on what to look for when comparing costs.)
Key Points
- The FDD is a 23-item document thatâs like an almanac for a franchise business youâre considering.
- The FDD is designed to promote transparency and protect the interests of both the franchisor and franchisee.
- Franchisors are required to provide prospective franchisees at least 14 days to review the FDD.
An item-by-item tour of the FDD
Buying a franchise might be stressful enough without the added pressure of a time-sensitive FDD review period. You get a minimum of 14 days in the United States, per FTC rules. Although that might seem like a lot of time, when you see just how extensive the 23-section document is, you might feel differently. If youâre intimidated by the scope of the information, consider contacting an attorney, franchise consultant, and/or a current franchisee to discuss.
Item 1: Franchisor background
This item provides a big-picture view of the franchisorâs background, including its history, parent companies, predecessors, affiliates, and special legal requirements (such as permits and licenses).
- Why this is important: This first item can help you better assess the risks and costs of pursuing a given franchise opportunity. What does the franchisor bring to the table in terms of experience?
Ray Kroc, McDonaldâs, and franchising
Item 2: Franchisorâs business background
Youâll want to learn about the executive team running the franchisorâs operations, including who they are, their business background, and how long they have been with the company.
- Why this is important: If the franchisor wrote the playbook and calls the shots from headquarters, then you (as a franchisee) are placing a lot of trust in their ability to run the operation. Global decisions can have local ramifications.
Item 3: Litigation history
Does the company have any pending or past lawsuits? Have any of the companyâs executives been convicted of any crimes? This part of the disclosure should reveal any legal actions that might affect the franchise.
- Why this is important: Lawsuits and criminal convictions can seriously impact a franchiseâs business and reputationâtwo things youâre paying a lot of money for. And if the franchisor has a habit of suing its franchisees (whether justified or not), it might make you reconsider signing an agreement with them.
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Item 4: Bankruptcy
All bankruptcies involving the franchisor, affiliates, parent companies, or executives are disclosed in this section.
- Why this is important: If youâre pinning your future success on a âprovenâ business model, your franchisor had better explain any past financial failures, along with those of its associated companies and executive officers.
Item 5: Initial fees
Initial fees typically include deposits and other franchise fees that must be paid up front before opening the franchise.
- Why this is important: Some of these fees may not be refundable, so pay attention to what youâre committing.
Item 6: Other start-up costs
This section discloses various costs for items like inventory, equipment, and rentals (or leases), among other things. The FDD includes a table of fee types, amounts, due dates, and any remarks from the franchisor.
- Why this is important: In a franchise transaction, neither party benefits from the perception of hidden fees. This section of the FDD should prevent any surprises as you incur various costs during the course of opening your business.
Item 7: Initial costs and fees
This section will tell you how much capital you need to buy and run the franchise, from initial investment to royalties. So, while item 5 discloses the initial fees to be paid to the franchisor prior to opening the business, this item estimates the total investmentâboth the preopening and running costsâfor the franchise.
- Why this is important: This big-picture view of current and forecasted expenses can help you decide whether you truly have the capital to take on such a large investment.
Item 8: Restrictions on sources of products and services
The franchisor tells you which products (or services) to buy and from whom.
- Why this is important: Suppose you could get similar yet cheaper supplies from another, non-approved vendor. Youâll have to figure out if the franchisor is benefiting financially from supplier exclusivity (and if so, whether you think itâs still a fair and favorable arrangement).
Item 9: Franchiseeâs obligations
These are all of the obligations you, as a franchisee, are expected to meet, laid out in a table for your reference. Items include your financial obligations (initial and ongoing), maintenance, insurance, advertising, sales quotas, reporting and recordkeeping, audits and inspections, and a host of other obligations that you may or may not have as a franchisee (many of which are spelled out in other sections in the FDD).
- Why this is important: These are the rules and standards you must follow in order to stay in compliance. Period.
Item 10: Financing
Some franchisors may offer financing arrangements; some may not. This section spells out the terms, coverages, and obligations included in any franchisor-sponsored financing.
- Why this is important: Some franchisors may require a specified level of net worth in addition to liquid assets. Furthermore, some franchisors (like McDonaldâs) will specify that your net worth or capital must not originate from borrowed funds. If the franchisor does offer financing, are the terms and conditions favorable?
Item 11: Franchisor training, advertising, and other support
Preopening and ongoing support can be critical to your success. Whether itâs employee training, advertising, computer system support, or any other form of support, this section tells you what you can expect.
- Why this is important: First, youâll want to make sure the support is adequate (this is where talking to other franchisees can be helpful). Plus, if youâre paying a portion of your sales to a general advertising fund, you might want to find out how itâs being allocated, say between national and regional ads.
Item 12: Territory restrictions
Your franchisor may impose territory restrictions, allocating an exclusive or âprotectedâ region where each franchisee can sell.
- Why this is important: If your franchisor or other franchisees operate websites or launch social media campaigns, you must decide whether such e-commerce strategies might compete with your region. And if youâre starting a franchise with the idea of expanding it to multiple locations, you should know if there are any preset boundaries near your expected reach.
Item 13: Trademarks
This item provides detailed information about the proper use of trademarks, trade names, service marks, and other elements related to the franchisorâs brand.
- Why this is important: The right to use a trademark is one of the big things youâve paid for, so be sure the context surrounding the use of the brand and the operational benefits and restrictions make the deal (and your investment) worthwhile.
Item 14: Patents, copyrights, and proprietary information
This section lays out the rules for using the franchisorâs intellectual propertyâpatents, copyrights, and trade secrets.
- Why this is important: Although the franchisor aims to make its intellectual property transparent to its franchisees, it also sets restrictions to safeguard that IP from competitors. Understanding the rules helps you avoid infringement risks.
Item 15: Obligation to participate in the actual operation of the franchise business
How involved must you be in operating the franchise? This item outlines your duties regarding direct involvement and management.
- Why this is important: In a nutshell, this item tells you how much time you need to spend on premises, including your level of involvement. It also clarifies what your franchisor expects from those you hire to manage the business. For example, itâs your responsibility to ensure that your store manager and employees follow the terms in the FDD (such as protecting the franchisorâs intellectual property).
Item 16: Restrictions on what the franchisee may sell
As a franchisee, your offerings must align with those of the franchisor. However, some agreements allow you to make slight tweaks to certain products or add new ones.
- Why this is important: This item specifies which products and services must be consistent across the board and whether you have any flexibility to make changes. For example, if you run a McDonaldâs franchise and you would like to offer Pepsi (PEP) products, that would be a nonstarter with the franchisor, as it would violate its long-standing exclusivity agreement with Coca-Cola (KO).
Item 17: Renewal, termination, transfer, and dispute resolution
Is your franchise agreement renewable? If so, how often, and what are the terms? Is the franchise transferable? Can you terminate in the event of a dispute with the franchisor (and vice versa)? The answers are in this section.
- Why this is important: This item clarifiesâin a tableâcontinuity and other conditions and risks of franchise ownership, including legacy transferability.
Item 18: Public figures
Are there any celebrities or public figures endorsing your brand? This section provides details on the nature of such associations, including their compensation and potential brand impact.
- Why this is important: Well-known spokespersons are a double-edged sword. What they say or do, even beyond the promotion, can help or hurt the brandâs perception.
Item 19: Financial performance representations (FPR)
Want to see the franchisorâs historical and projected earnings, along with explanations, including disclaimers and caveats? This section covers it. However, the franchisor is not required to provide this information.
- Why this is important: If a franchisor opts out of providing this item, it isnât necessarily a red flag. The franchisor might have a legitimate reason (for instance, new franchisors may not have enough history to provide an adequate FPR). Opting out of providing an FPR shouldnât raise your suspicion, but it does call for caution.
Item 20: Outlets and franchisee information
Do you want data on other franchisees (or businesses owned by the franchisor), including their locations and how to contact them? Item 20 covers this (and much more). Item 20 includes tables covering the number of outlets held, opened, closed, transferred, and plannedâboth franchised and company ownedâat the start and end of each year, broken out by state.
- Why this is important: This section provides an overview of the entire franchise system, including success and turnover rates, its growth strategy, and geographic or demographic conditions that contribute to a franchiseeâs success or failure. Is the overall franchise growing or shrinking, and how quickly?
Financial statements overview
Item 21: Financial statements
Here you get to see three years of audited financial statements. These include income, cash flow, and balance sheets.
- Why this is important: This is your opportunity to assess the franchisorâs financial stability. If you want to dig deeper, most publicly held companies provide an archive of their financial statements in an investor relations section of their websites.
Item 22: Contracts
This item shows you all of the legal agreements youâre required to sign in order to become a franchisee.
- Why this is important: Most of these agreements are written in âlegaleseââa language most humans arenât accustomed to. Before you sign anything, consider hiring a professional who can understand and clearly explain the legal terms in each contract.
Item 23: Receipts
This is basically a form you sign to acknowledge that youâve received the FDD.
- Why this is important: By signing the receipt, you agree that youâve had enough time to review the FDD. If you should experience a dispute regarding the FDD, this receipt can be used as evidence to help resolve it.
The bottom line
The FDD is a criticalâand mandatoryâresource for anyone looking to try their hand in the franchise business. By thoroughly analyzing the information it provides, youâll be empowered to better decide whether the opportunities and risks inherent to the business align with your goals, risk tolerance, capital, time, and stress levels.
And if youâre perusing different FDDs in your search for the perfect franchise, consider these nine tips on how to choose a franchise.
This article was most recently revised and updated by Karl MontevirgenThis article was most recently revised and updated by Doug Ashburn
