What is it, and why do I care?
By now you’ve considered maybe a dozen franchise opportunities. You’re really excited about the franchise brand or concept you found. You like the web site, you see the growth potential, and you think it’s a fit. You ask for more information.
Boom. A 200+ page document lands on your desk: The Franchise Disclosure Document (FDD). Do not use it as a paperweight or a booster seat. There is some really important stuff in there that you need to understand before you begin a financial relationship with the franchisor (the person or company who owns the franchise brand).
If you hate surprises, read the whole thing -- especially the actual Franchise Agreement (in the Exhibit section). At the very least, become familiar with the following sections. They are just a snapshot of what you really need to read before you sign anything.
Page 1: There should be a cover page that gives a brief overview of the nature of the business, the start up costs, and the franchise arrangement.
Section 1: The Franchisor. You should know with whom you will be doing business. This section details how long the company has been in business, how the business is organized, and whether there is a parent company, affiliates or subsidiaries. It also may address competition, laws, licensing and permits required.
Section 2: Business Experience. This section lists the leadership team and their position with the company, and may even list other industry experience. Make sure there is sufficient support and expertise in operations, marketing and technology for you to be successful.
Section 3: Litigation. Don’t be alarmed. Many new and growing franchise brands could be involved in some legal action. The number of law suits isn’t important. But the nature of the complaint and how it was resolved are. Does the complaint affect your ability to be successful? Do you think the franchisor acted fairly? Would you want them to resolve your concerns in a similar fashion?
Section 6: Other Fees. These are ongoing fees after the initial start-up costs, such as advertising, technology, and of course, royalty. These fees help the franchisor maintain the brand and provide quality support systems so you can be successful. Potential penalties should also be noted in this section.
Section 7: Estimated Initial Investment. In addition to the franchise fee, there are other costs that will be included in initial or start-up fees. For example, deposits and rental costs, commercial space, equipment, food or product inventory, or build out required to get the business started.
Section 17: Renewal, Termination, Transfer and Dispute Resolution. This section covers your exit strategies. At some point you may decide you don’t want to own this business anymore. Proper planning is key for future success.
Renewal – Renewal at contract end may not be automatic. Know the terms of renewing your Franchise Agreement and what might put you at risk. Renewal may not be up to you -- it may be at the franchisor’s discretion,
Termination – In most cases, a franchisor can terminate your contract for any number of reasons. Understand them and be sure that you can live by those rules.
Transfer – Transfer is especially important if you are buying a franchise business to build an asset. This section details your right to transfer to another buyer who will assume your business assets. Many franchisors reserve the right to approve the candidate in a transfer. So just because Jo is your relative, doesn’t mean the franchisor will let him or her take over the business.
Dispute Resolution – Know your franchisor’s preferred method of dispute resolution. The results may be binding and you should be comfortable with how disputes are handled.
Section 19: Earnings Claim or Financial Performance Representation. This section may or may not be included as it is not a required section. By law, franchisors are only allowed to discuss performance information if it’s already published in the FDD. What if there is no information in the FDD? The franchisor will not discuss financial performance of the franchises. But you can and you should ask other franchisees and former franchisees as part of your research or due diligence.
Section 20: Outlets and Franchisee Information. Do not skip calling others! In the Exhibit section, the Franchisor provides a list of current and former franchisees. It is well worth your time to call at least 10 current and former franchise owners and ask them about their experience with the franchisor you are considering. You can choose them randomly or look for ones in a market similar to yours. If you don’t know what to ask, see this list of questions.
For more information, see Guide to Buying a Franchise.