Franchise Basics: What is a Franchise Disclosure Document?

In Short:

In 1978, the Federal Trade Commission implemented the FTC Rule. The FTC Rule requires that franchisors file a Franchise Disclosure Document (FDD) annually and provide it to every potential franchise buyer at least 14 days before a franchise sale can be completed.

The FDD exists for two primary reasons: to protect potential buyers as a candidate and to protect the franchisor against allegations of misleading claims. The document is typically updated once a year (during filing) or when a material change occurs in the franchised business.

A Franchise Disclosure Document includes 23 specific pieces of information (called items), the franchisors franchise agreement, and various exhibits (like a list of current and past franchisees, and audit financials of the franchisor.

Buying a franchise is a complex investment. The information in a franchise disclosure document can help you make up your mind. More information on franchising, such as “A Consumer’s Guide to Buying a Franchise,” which can help you understand how to use a disclosure document, is available from the Federal Trade Commission. You can contact the FTC at 1-877-FTC-HELP or by writing to the FTC at 600 Pennsylvania Avenue, NW, Washington, D.C. 20580. You can also visit the FTC’s home page at www.ftc.gov for additional information. Call your state agency or visit your public library for other sources of information on franchising.

There may also be laws on franchising in your state. Ask your state agencies about them.

The Franchise Disclosure Document (FDD)

The goal of the FDD is to provide buyers with information that they can use to make a buying decision. Federal law (The FTC Rule) requires that franchisors file annually a Franchise Disclosure Document (FDD) and provide it to every potential franchise buyer. FDD’s provides a tremendous amount of incite on a franchisors offering and health of the organization. (it is a lot like reading a public company’s corporate 10k filing.) and should be reviewed with industry professionals. (a franchise attorney and an accountant)

Franchisors are required to provide prospective Franchise candidates their FDD upon request at least 14 days ( requirements may be different on a state-by-state basis) before you sign a binding agreement with, or make a payment to a franchisor or any of its affiliates. They are also required to update the document annually or when there is a material change.

An FDD includes 23 specific pieces of information (called items), The franchisors franchise agreement, and various exhibits ( like a list of current and past franchisees, and audited financials of the franchisor.

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This is a sample FDD cover page. Usually a brand will deliver you their FDD in .PDF over email.

Summary of the 23 Items in a Franchise Disclosure Document

Item 1: The Franchisor and any Parents, Predecessors, and Affiliates

Item 1 provides an overview of the background and history of the franchisor. A few important things to look for include, how long has the franchisor has been in business as well as if the franchisor has started any other businesses or had a predecessor. The history of a franchise can provide a more complete understanding of the company’s future growth and success. In addition the item provides a summary of the business being franchised as well as the type of franchise agreement as well as any competition or regulations the Franchisor is aware of that affect the business offering.

Item 2: Business Experience

This item identifies the executive involved with the franchisor as well as a summary of their backgrounds and experience.

Item 3: Litigation

This section provides information on prior litigation - whether the franchisor or any of its executive officers and directors have been convicted of felonies relating to fraud, violations of franchise law, or unfair and /or deceptive practices law, or are subject to state or federal injunctions involving similar misconduct. In addition, this section will also list whether any of the franchisors executive have been held liable for - or settled civil actions involving the franchise relationship.

If there are significant claims listed against the franchisor it may indicate that franchisees are unhappy with the franchise system.

In addition, this section should also list if the franchisor has sued any of its franchisees during the last year. An example would be a franchisor suing for unpaid royalties which could be an indicator that franchisees are unsuccessful.

Item 4: Bankruptcy

Item 4 of the FDD provides information regarding the financial situation of the franchisor. franchisors are required to disclose whether the company or any of its executives have recently been involved in bankruptcies. Franchisors may provide context in addition to the information.

Item 5: Initial Fees

This section provides a summary of the upfront fees associated with the purchase and operation of a franchise. Typical fees may include: franchise / development Fees (and associated deposits), upfront equipment / supply purchases, tech / software fees, delayed opening fees, training / certification and opening assistance fees.

Item 5 should be reviewed carefully. All or many of these fees are typically not refundable and vary wildly from franchisor to franchisor.

Item 6: Other Fees

Item 6 provides a summary of additional non-refundable fees related to the operation of the franchised business. Typically a franchisors Item 6 will include their royalty as well as ad-fund rates (which can be a percentage of revenue or fixed dollar values depending on the franchise), other fees that may be listed may include but not limited to transfer fees, additional training fees, insurance premiums, and costs for attending conferences as well as potentially punitive fees (Interest on late payments, insufficient funds fees, audit expenses, etc)

Be sure to read through each fee, when the fee is due, the amount, and any remarks / notes associated. It is highly recommended that anyone lookinging into a franchise speak to a franchise attorney to better understand the remarks and notes associated with each fee.

Item 7: Estimated Initial Investment

This section typically consists of a table that outlines the expenses a franchisee would pay to start the franchised business (and in some cases funds necessary for first 90 days).

The chart may include such fees as upfront franchise / development fees, rent, security deposits, utilities, insurance payments, equipment, training fees, professional fees, leasehold improvements, computers / AV equipment, signage, travel, additional funds, etc.

Franchisees should pay close attention to this chart which will involve a range and should heavily diligence all expenses when creating their business plan.

Item 8: Restrictions on Sources of Products and Services

Item 8 is highly depended on the type of franchise you are diligencing. This section will cover the franchisor's relationship with suppliers as well as authorized suppliers and any restrictions or obligated purchases.

Item 9: Franchisee’s Obligations

This section is typically represented as a table. The table lists the franchisees principal obligations under the franchise and other agreements. The table will reference various sections of the FDD to reference more detailed information on your obligations.

Item 10: Financing

In this item franchisors will disclose financing available to franchisees. Some franchisors offer financing plans packages / terms, others do not.

Item 11: Franchisor’s Assistance, Advertising, Computer Systems, and Training

Item 11 covers what the franchisee should expect when it comes to assistance or training from the franchisor. This includes a summary of the franchisors training program which is typically represented as a training agenda in chart format with associated hours of training provided.

Franchisees should consider the time associated with training for themselves and potentially their staff and / or hired Manager.

Item 12: Territory

This section covers territory the franchisee will receive. Item 12 varies greatly from franchise to franchise, depending on company specifics.

Item 13: Trademarks

Purchasing a franchise provides the right to use a companies trademark for a certain period of time (it is an exciting feature of franchising.) Item 13 of the FDD will provide a summary of the company’s trademarks and how they can be used by the franchisee.

Item 14: Patents, Copyrights, and Proprietary Information

Similar to Item 13, this section will disclose pending and current patents, copyrights, or other relevant proprietary information.

Item 15: Obligations to Participate in the Actual Operations of the Franchise Business

This section provides an overview of operational obligations of the franchisee. Be sure to review this section in detail to ensure you are prepared to operate the business in compliance with the Franchisors expectations.

Some brands will expect you to operate your franchise as an active investment and may require you to hire a general manager or equivalent that has received specific training to operate the business.

In addition, Item 15 will also cover expectations around who is required to sign payment and performance guarantees as well as nondisclosure and noncompete agreements.

Item 16: Restrictions on what the Franchisee May Sell

Item 16 provides a summary of what product or services a franchisee may sell, what suppliers they should use, and where they may sell it.

Item 17: Renewal, Termination, Transfer, and Dispute Resolution Procedures

In this section franchisee can review terms, rights, and restrictions related to the termination or transfer of the Franchise Agreement.

Franchisors are also obligated to disclose the methods used to resolve legal disputes. Some franchisors may prefer to settle disputes through arbitration, rather than the court system.

Item 18: Public Figures

This section will disclose any public figures that may be involved with the franchise.

If a public figure (for example: a major athlete) is associated with the franchise, franchisors must disclose any arrangements made with the figure in this item. Which may include any benefitsor roles duties provided as well as information on investment.

Item 19: Financial Performance Representations

The section will include any of the franchisors financial performance representations.

The FTC’s Franchise Rule permits a franchisor to provide information about the actual or potential financial performance of its franchised and/or franchisor - owned outlets, if there is a reasonable basis for the information, and if the information is included in the disclosure document.

There is no assurance your business will achieve the same results. You should always review this information carefully with a franchise attorney and accountant.

Item 20: Outlets and Franchisee Information

Item 20 provides an outline of the company’s franchised locations from the previous three years. This item of the FDD gives prospective franchisees an idea of the size and growth of the franchisor.

In addition to the number of units, this section will also provide directions to the contact information of existing franchisees in the system as well as franchisees that have recently left the franchise.

It is recommended that anytime you are looking into a franchise, you call as many franchisees as you can to fully diligence the offering.

Item 21: Financial Statements

Item 21 includes audited financial statements of the franchisor for prospective candidates to review. These financial statements will provide clarity on the financial health of a franchisor.

It is recommended you review this section thoroughly with an accountant.

Item 22: Contracts

All agreements and contracts that a potential franchisee is expected to sign in their state for the franchise offering are provided in item 22. Of the documents attached is the Franchise Agreement.

Item 23: Receipts

The last two pages of every Disclosure Document are acknowledgements that you received the Disclosure Document (as required by Federal Law). Franchisors will request that you sign and return the receipt pages upon receiving the documents. Franchisors are required at minimum to provide you 14 days to review the FDD in full. It is recommended you review the document with a Franchise Attorney and an Accountant.