The anatomy of an FDD
Anyone interested in starting or investing in a franchise should be familiar with the Franchise Disclosure Document, which is commonly known as the FDD. Yet it’s not a quick read – this critical document can run incredibly long, sometimes over 300 pages. With so much information to digest, how do you find your way to exactly what you need?
In this guide, you’ll learn:
- What an FDD is
- The sections of an FDD
- How to get and use an FDD
What is an FDD?
As the name implies, a Franchise Disclosure Document (sometimes called a Uniform Franchise Disclosure Document) is a legal disclosure document with information about a particular franchise. When individuals have expressed interest in buying a U.S. franchise, the FDD must be provided to them as part of the pre-sales due diligence process. The potential buyer(s) must receive the FDD at least 14 days before they’re asked to sign a contract or pay any money to the franchisor or its affiliates.
The FDD contains all the financial and legal information that the buyer needs to make an informed decision about whether to invest in that franchise.
The sections of an FDD
U.S. law – specifically Franchise Rule 16 CFR Parts 436 and 437 – requires each Franchise Disclosure Document to contain the following sections, in order:
Item 1: The Franchisor and Any Parents, Predecessors, and Affiliates
This section describes the history of the franchise, including how long the business has been running and when it started franchising. Also included in this section are any legal requirements unique to the franchised business, such as the need to get any special licenses or permits.
Item 2: Business Experience
The business experience section outlines the background and experience of the franchise’s executive team, including directors, principal officers, and other key executives.
Item 3: Litigation
This section covers any previous and pending actions against the franchise and its executive officers pertaining to the franchise relationship. It also lists any instances of the franchise suing a franchisee if that has occurred within the past year.
Item 4: Bankruptcy
This section discloses any bankruptcies involving the franchise, predecessors, executives, or affiliates.
Item 5: Initial Fees
Item 5 covers the initial fees that a new location owner needs to pay to the franchisor to start operating the franchise.
Item 6: Other Fees
Item 6 covers any other fees associated with operating the franchise. There should be no hidden, undisclosed, or surprise fees related to franchise ownership, as they must all be listed in this section.
Item 7: Estimated Initial Investment
This is the estimated total upfront investment needed to start a new franchise location, including the initial fee(s). Item 7 is always given as a range between low and high estimates, and it includes start-up costs like initial inventory, estimated cost of space rental, and other operating expenses.
Item 8: Restrictions on Sources of Products and Services
This section discloses any ownership or financial relationship between the franchise and its suppliers. More broadly, it explains the restrictions the franchisor can put on the business, including what and where you can buy/sell. Additional geographical restrictions and/or sales territories are covered in more detail in Item 12.
Item 9: Franchisee’s Obligations
FDD Item 9 discloses a franchisee’s principal obligations in a three-column table, which references where more information can be found.
Item 10: Financing
The financing section outlines the existence, conditions, and terms of any financing arrangements that the franchisor offers, including lease and installment contracts.
Item 11: Franchisor’s Assistance, Advertising, Computer Systems, and Training
In this section, the franchisor discloses its obligations to assist franchisees, including both pre-opening and ongoing assistance. Typically, the section covers assistance with advertising and any specialized job training required to successfully operate the franchise.
Item 12: Territory
If there are any geographical restrictions to doing business (such as to prevent franchisees from competing too closely with each other), they’ll be outlined in this section of the FDD.
Item 13: Trademarks
This section discloses any registered trademarks owned by the franchise.
Item 14: Patents, Copyrights, and Proprietary Information
Any patents, copyrights, or proprietary information not covered under the previous section will be disclosed here.
Item 15: Obligation to Participate in the Actual Operation of the Franchise Business
This section outlines the franchisee’s obligations for direct participation in the business’s operations.
Item 16: Restrictions on What the Franchisee May Sell
If the franchisee can only sell certain goods and services, those restrictions will be outlined here.
Item 17: Renewal, Termination, Transfer, and Dispute Resolution
This section outlines renewal terms and exit strategies for the franchisee, including the process of selling the franchise if they wish to end the relationship with the franchisor. Also included are any non-compete agreements that former franchisees are required to uphold after their relationship with the franchisor has been terminated.
Item 18: Public Figures
Any person whose name or likeness is associated with the franchise will be disclosed here.
Item 19: Financial Performance Representations
Item 19 is optional and outlines any claims the franchisor chooses to make about sales or earnings. If such claims appear outside Item 19 and are not also included in this section, they deserve some extra due diligence.
Item 20: Outlets and Franchisee Information
Item 20 discloses franchise growth and any owner turnover in the last three years. It also includes existing franchisee contact information. As part of the due diligence process, interested individuals can contact and ask these franchisees about their experience with the franchisor.
Item 21: Financial Statements
In this section, the franchisor must disclose the three most recent years of audited financial statements, including balance sheets, statements of operations, owner’s equity, and statements of cash flows.
Item 22: Contracts
This section discusses the requirement that the franchisor attach copies of all proposed agreements related to the franchise offering, including (but not limited to):
- Financing agreements
- Purchase agreements
- Product supply agreements
- Software licensing agreements
- Personal guarantees
- The franchise agreement
Item 23: Receipts
The final section of the FDD generally includes five sub-sections: a required preamble, franchise seller information, the issuance or effective date of the FDD, a list of FDD exhibits, and a signature block with room for the prospective franchisee to sign and date when they’ve received the FDD.
The final component is especially important because federal law requires that prospective franchisees receive the FDD at least 14 days before they’re asked to sign a contract or send money to the franchisor or its affiliates.
How do you get an FDD and how should you use it?
The easiest way to get an FDD is to simply ask a franchisor for it. That said, four states publish the FDDs of franchises operating in their state and make them available online:
- California (https://docqnet.dfpi.ca.gov/search/)
- Indiana (https://securities.sos.in.gov/public-portfolio-search/)
- Minnesota (https://www.cards.commerce.state.mn.us/)
- Wisconsin (https://www.wdfi.org/apps/FranchiseSearch/MainSearch.aspx)
You can also subscribe to a franchise analytics platform like Krokit, where many franchises have uploaded sample PDFs of their FDDs.
However, as information in the FDD is subject to change, you should always treat FDDs you find online as approximations, and instead refer primarily to the FDD provided after entering a conversation with the franchisor.
The FDD is an invaluable tool when it comes to researching potential franchise options, whether as a potential future owner or as an investor. Items 2, 7, 15, and 20 are a good place to start your due diligence; collectively, they provide a snapshot of the overall state of the franchise, its leadership, and its operations. These sections are also heavily scrutinized by government-backed lenders like the Small Business Administration when a potential buyer applies for financing.
However, once you’ve taken a look at the big picture, it is still critical to examine the entire FDD from beginning to end before committing to a franchisor. It’s a unique opportunity to take a look at the inner workings of a company and evaluate how the franchisor’s practices fit your financial and lifestyle goals.
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