Though a Franchise Disclosure Document (FDD) at 200 or 300 pages in length may appear very daunting at first glance, you should relax and just take your time to review it in pieces. I believe that there are 5 “Items” from the FDD that merit initial attention. If you review these first, you will gather important information that you need early in your franchise investigation and can then digest the additional information as your process proceeds.
Item 2 – Business Experience
In Item 2, the senior leadership and Board of Directors of the franchise company will outline their bios in varying amounts of detail. When I read this section, I am searching for key signals of success such as:
– Does the leadership team have relevant industry experience?
– Do they have strong backgrounds in franchising?
– Has the leadership team been with this brand for a brief or long period of time?
– Do their bios build confidence for you in the brand?
Item 3 – Litigation
Unfortunately, we live in a litigious society. Item 3 of the FDD mandates that franchise companies disclose all litigation history of the brand. This will include litigation between the franchisor and franchise owners, with vendors, with customers or with other business partners.
As I review this section, I am looking for (1) patterns and (2) volume. If this is a brand that has been operating for 10 years and has a grand total of 2 disclosures in the litigation section, I feel confident that the brand is a sound company that is treating its business partners with respect.
Item 7 – Estimated Initial Investment
In Item 7, the franchise company presents a low and high range of initial required investment for a new franchise owner to start the business. It is important to review this information (including the related notes) early in the investigation so that you can judge quickly if this opportunity is affordable to you.
When you are reviewing the Item 7, please make note of the amount of working capital that is included in the estimates. This should give you some indication of the estimated time between the startup of the business and when the franchise company believes you will be profitable.
Item 19 – Financial Performance Representations
Franchise companies have the options, but not the requirement, to disclose financial performance in Item 19. Recently, the trend has been toward more disclosure and transparency in this area but there is a wide range of disclosure types. Many brands will disclose more detailed information about revenue and less detail about expenses and net profitability. Some brands will provide detailed financial disclosure for their company owned units and less about franchisee owned units. In general, more information here is helpful but this is only a starting point for understanding the financial picture of a franchise opportunity. Much more detail will come from your future due diligence.
Item 20 – Outlets and Franchisee Information
I find the information is Item 20 to be very helpful at early stages of the investigation. In Item 20, the franchisor discloses the net changes in open units during the prior 3 years. Item 20 presents a detail of new unit openings, transfers from one owner to another, franchisor re-purchases or divestments and closures. Item 20 provides some objective data and we can use as a proxy for “success rate” by studying what has occurred during the past 3 years.
If you are ready to discuss more about Franchise Disclosure Documents or franchising in general, contact Chris Cynkar by telephone at 412-877-2000, by email at ccynkar@franchoice.com or visit www.chriscynkar.com.
