“The man who does not read has no advantage over the man who cannot read.”- Mark Twain
You are entitled to receive the Franchise Disclosure Document (FDD) at least 14 days before signing any contract or making any payment to the franchisor or its affiliates. In fact, once the franchisor has received your application and agreed to consider it, you have the right to request the FDD. If you don’t get it, speak up and ask plenty of questions as you go through the FDD and its related documents.
The franchisor’s behavior surrounding the FDD can also reveal potential concerns about their business practices. While providing the FDD is a legal requirement and doesn’t necessarily reflect the franchisor’s credibility, delays in delivering it, incomplete information, dodging your questions, or trying to rush you through the process may indicate issues with their compliance.
Once you have the FDD, it’s time to examine the 23 required items, paying attention to key details as you review it.
What is a Franchise Disclosure Document?
The Franchise Disclosure Document (FDD) is a legal document that franchisors must provide to prospective franchisees. It contains essential information about the franchise, including the franchisor's history, fees, obligations, and more. The FDD's primary purpose is to provide transparency and protect potential franchisees from deceptive practices.
Why is the FDD Important?
Understanding the FDD is critical for anyone considering a franchise opportunity. This document helps you assess the viability and risks associated with the franchise. By thoroughly reviewing the FDD, you can make an educated decision and avoid potential pitfalls. The FDD ensures that you have all the necessary information to evaluate the franchise offering, thus promoting transparency and trust between the franchisor and franchisee.
History of the Franchise Disclosure Document
The FDD was introduced in 1978 by the Federal Trade Commission (FTC) to regulate the sale of franchises in the United States. Before the FDD, there were no standardized requirements, leading to misleading and fraudulent practices.
The FTC's regulation aimed to protect franchisees by ensuring they received sufficient information to make informed decisions. Over the years, the FDD has undergone several revisions to enhance disclosure requirements and provide greater protection to franchisees.
Key Components of the FDD
The FDD consists of 23 specific items, each providing crucial information about the franchise. These items cover various aspects, including the franchisor's background, fees, obligations, and financial performance representations. Understanding these components will help you evaluate the franchise opportunity comprehensively.
FDD ITEM 1 The Franchisor's Background
Item 1 of the FDD provides an overview of the franchisor's background. It includes details about the company's history, ownership, and business experience. This section helps you understand the franchisor's track record and their ability to support and grow the franchise system. By examining the franchisor's background, you can gain insights into their expertise and commitment to the success of the franchise.
FDD ITEM 2 Business Background
Item 2 identifies the executives of the franchise system and describes their experience. Pay attention to their general business backgrounds, their experience in managing a franchise system, and how long they’ve been with the franchisor.
FDD ITEM 3 Litigation History
Item 3 lists important information about prior litigation — whether the franchisor or any of its executive officers have been convicted of felonies involving fraud, violations of franchise law, or unfair or deceptive practices law, or are subject to any state or federal injunctions involving similar misconduct.
This item will tell you whether the franchisor or any of its executives have been held liable for — or settled civil actions involving — the franchise relationship. If there have been many claims against the franchisor, it may mean the franchisor has not performed according to its agreements. Or it could show that franchisees are dissatisfied with its performance. Item 3 also should say whether the franchisor has sued any of its franchisees during the last year.
That disclosure may indicate common types of problems in the franchise system.
For example, if a franchisor sued franchisees for failing to pay royalties, it could be because franchisees weren’t successful, and weren’t willing or able to make their royalty payments.
FDD ITEM 4 Bankruptcy
Item 4 discloses whether the franchisor or its predecessor, affiliates or any of its executives have been involved in a recent bankruptcy. If the franchisor or its predecessor or affiliate has declared bankruptcy, carefully review the franchisor’s financial statements in Item 21 of the FDD to see if the franchisor is financially capable of delivering the support services it promises. Consider having an accountant review the required financial statements too.
FDD ITEMS 5-7 Initial and Ongoing Costs
Item 5 of the FDD outlines the initial fees and investment costs associated with the franchise. This section provides a breakdown of the expenses you can expect, including the initial franchise fee, equipment costs, training fees, and more. Understanding these costs is crucial for budgeting and determining the financial feasibility of the franchise opportunity. By carefully reviewing the initial fees and investment costs, you can ensure that you have the necessary financial resources to start and sustain the franchise.
Item 6 of the FDD details the ongoing fees and royalties that franchisees must pay to the franchisor. These fees typically include royalties, advertising contributions, and other ongoing expenses. It is essential to understand these financial obligations to assess the long-term profitability of the franchise. By analyzing the ongoing fees and royalties, you can evaluate the financial viability of the franchise and determine if it aligns with your business goals.
Item 7 of a Franchise Disclosure Document (FDD) outlines the estimated initial investment required to start a franchise. This section provides a detailed breakdown of the costs a franchisee will likely incur before and shortly after opening their franchise location.
The key costs typically listed in Item 7 include:
Initial franchise fee
Equipment, signage, and fixtures
Real estate and leasehold improvements
Initial inventory
Insurance
Grand opening marketing
Professional fees (legal, accounting)
Additional working capital needed for the first few months of operation
This information helps potential franchisees understand the upfront costs associated with launching the franchise and allows them to assess the financial commitment required.
FDD ITEM 8 Restrictions on Sources of Products and Services
Item 8 of the Franchise Disclosure Document (FDD) addresses restrictions on sources of products and services. It specifies whether the franchisor requires franchisees to purchase or lease certain goods, services, or equipment only from approved suppliers or the franchisor itself. This section is important because it outlines the level of control the franchisor has over a franchisee's supply chain and operations.
Key points typically covered in Item 8 include:
Approved suppliers: If the franchisor mandates that certain products or services must be bought from specified vendors.
Exclusivity: Whether franchisees are restricted to purchasing goods exclusively from the franchisor or its affiliates.
Criteria for approval: How a franchisee can request approval to use a supplier that is not on the approved list.
Revenue from suppliers: Whether the franchisor or its affiliates receive any rebates, commissions, or other compensation from suppliers.
Impact on costs: Any potential effect on a franchisee’s costs due to these sourcing restrictions.
This section helps franchisees understand their obligations regarding procurement and how it might impact their operating flexibility and costs.
FDD ITEM 9 Franchisee Obligations and Support
Item 9 of the FDD outlines the franchisee's obligations and the support provided by the franchisor. This section details the training programs, marketing assistance, and ongoing support that franchisees can expect. Understanding these obligations and support systems is crucial for evaluating the level of assistance you will receive from the franchisor. By reviewing this section, you can determine if the franchisor provides the necessary resources and support to help you succeed in your franchise venture.
FDD ITEM 10 Financing Arrangements
Item 10 of the Franchise Disclosure Document (FDD) covers Financing Arrangements. It details any financial assistance the franchisor or its affiliates may offer to franchisees, either directly or through third-party lenders. This can include loans for franchise fees, equipment, real estate, or other start-up costs.
Key information in Item 10 includes:
Financing terms: Interest rates, repayment schedules, and collateral requirements.
Conditions: Any specific conditions or qualifications required to be eligible for the financing.
Franchisor's rights: Whether the franchisor can accelerate payments, repossess equipment, or terminate the franchise if the franchisee defaults on financing.
Third-party financing: If the franchisor helps secure financing through partnerships with external lenders.
This section is crucial for franchisees seeking financial assistance to understand their options and obligations related to financing their franchise.
FDD ITEM 11 Franchisor Obligations
Item 11 of the Franchise Disclosure Document (FDD) addresses the Franchisor’s Assistance, Advertising, Computer Systems, and Training Programs. It outlines the support and resources that the franchisor provides to franchisees, both at the initial stage and on an ongoing basis. This item is essential because it informs franchisees about what kind of help they can expect from the franchisor in setting up and running their business.
Key components typically included in Item 11 are:
Initial Assistance:
Support in selecting a site and setting up the franchise (e.g., store layout, equipment, inventory).
Assistance in the grand opening or initial marketing efforts.
Advertising:
The franchisor’s advertising programs, such as national, regional, and local advertising.
The percentage of sales franchisees must contribute to advertising funds.
Whether franchisees have control over how advertising dollars are spent and whether any commissions or rebates are given to the franchisor.
Training:
The initial training program provided to new franchisees and their staff.
Information about the trainers, their qualifications, and the content and duration of the training.
Ongoing training opportunities or refresher courses, including any associated costs.
Computer Systems:
Required software or hardware systems, including point-of-sale systems, inventory management, and any proprietary technology.
Maintenance, updates, or technical support offered by the franchisor.
Ongoing Support:
Regular field support, access to a helpline, or troubleshooting assistance.
Any business management or operational support the franchisor provides on an ongoing basis.
Item 11 is critical for understanding the franchisor's role in helping franchisees succeed and ensuring that franchisees know what resources they will have access to throughout their relationship.
FDD ITEM 12 Territory and Location
Item 12 of the FDD addresses the franchisee's territory and location. This section defines the geographic area in which the franchisee can operate and whether exclusivity is granted. Understanding the territory and location provisions is essential for assessing the market potential and competition within your area. By analyzing this section, you can determine if the assigned territory provides sufficient opportunities for growth and profitability.
FDD ITEM 12 Territory
Item 12 of the Franchise Disclosure Document (FDD) focuses on Territory. It provides details regarding the territory granted to the franchisee, outlining any geographic or market area restrictions and protections that will impact the franchisee's business operations.
Key aspects covered in Item 12 include:
Exclusive or Non-Exclusive Territory:
Whether the franchisee will have an exclusive territory, meaning no other franchisees or company-owned locations can operate in that area.
If non-exclusive, the possibility of the franchisor or other franchisees opening outlets or selling in the same territory.
Restrictions on Franchisee’s Activities:
Limitations on where the franchisee can operate (e.g., specific geographic boundaries) and whether the franchisee can sell products or services outside the territory.
Any restrictions on using the internet or other marketing methods to reach customers outside the territory.
Franchisor's Rights in the Territory:
Whether the franchisor can open competing businesses, sell through alternative channels (e.g., online, via catalogs, or third-party platforms), or distribute products within the franchisee’s territory.
Any rights the franchisor reserves to modify the size or boundaries of the franchisee's territory over time.
Impact of Sales and Performance:
Conditions under which a franchisee might lose their territory, such as failing to meet certain performance or sales criteria.
Whether the territory could be reduced or adjusted if the franchisee does not maintain specific sales levels.
Item 12 is crucial because it defines the competitive landscape and the franchisee's operational rights within a certain area, affecting business potential and the risk of internal competition.
FDD ITEM 13 Trademarks
Item 13 of the Franchise Disclosure Document (FDD) focuses on Trademarks. It provides information regarding the trademarks, service marks, trade names, logos, and other commercial symbols that the franchisor grants the franchisee the right to use in connection with the franchise.
Key points covered in Item 13 include:
Ownership and Registration:
It discloses whether the franchisor owns or has the legal rights to the trademarks being licensed to the franchisee.
Information on whether the trademarks are registered with the U.S. Patent and Trademark Office (USPTO) or in other relevant jurisdictions.
Legal Risks or Conflicts:
It lists any current or potential legal challenges to the trademarks, such as pending lawsuits, disputes, or claims by third parties.
If there are conflicts or unresolved issues regarding the ownership or use of the trademarks, this section will disclose them, informing the franchisee of potential risks.
Franchisee Rights and Limitations:
The scope of the franchisee’s right to use the trademarks, including any restrictions on how and where they can be used.
Conditions under which the franchisee may lose the right to use the marks, such as non-compliance with the franchise agreement.
Protection and Enforcement:
The franchisor’s responsibility for protecting and defending the trademarks, including actions taken to enforce trademark rights against infringers.
The role of the franchisee in protecting trademarks and notifying the franchisor of any infringements.
Item 13 is crucial because it ensures the franchisee understands the status of the trademarks they will be using and any potential legal issues that could impact the business's branding and identity.
FDD Item 14 Patents, Copyright and Proprietary Information
In Item 14, the franchisor is required to provide details about any patents, copyrights, and other proprietary information associated with the franchise system. These elements—proprietary information, copyrights, and sometimes patents—play a crucial role in many franchise systems.
Franchisees must understand any legal protections, licenses, or restrictions related to the intellectual property they will utilize or access in their day-to-day operations, which can range from the contents of an operations manual to copyrighted materials and equipment that use patented processes. Potential franchisees should be able to find this information in Item 14 of the Franchise Disclosure Document (FDD) before making any investment decisions.
In the following sections, we will examine the disclosures regarding patents, copyrights, and proprietary information that franchisors must include in Item 14, helping prospective franchisees appreciate the importance of investing in a brand that values intellectual property rights.
FDD ITEM 15 Obligation to Participate in the Actual Operation of the Franchise Business
This section addresses the extent to which the franchisee (or their management team) is required to be personally involved in the day-to-day operations of the franchise. Key points covered include:
Personal Involvement Requirement:
Whether the franchisee is required to personally manage and operate the business on a full-time basis or if they can appoint a manager to do so on their behalf.
Management by Designated Personnel:
If the franchisee is allowed to hire a manager, this item will specify any qualifications or training that the manager must have.
It may outline any restrictions or requirements concerning who can manage the franchise (e.g., the manager must attend training or meet specific franchisor criteria).
Ownership and Operational Obligations:
This section also discusses whether the franchisee must maintain a certain level of ownership in the business to continue operating it, as well as any other conditions that may apply to ensure consistent involvement in the franchise's success.
Absentee Ownership:
Some franchisors allow for absentee ownership, where the franchisee does not need to be involved in day-to-day operations, while others require more direct oversight by the franchisee.
Item 15 is critical for franchisees to understand their expected role in managing the business and whether they have the flexibility to delegate operational duties.
FDD ITEM 16 Restrictions of What the Franchise May Sell
In Item 16, the franchisor is required to disclose its control over what products or services a franchisee can sell as part of the franchised business. Ensuring consistency in the offerings across various locations within a franchise system is essential for the brand's success.
Uniformity contributes to a positive and dependable experience for customers visiting different outlets, so franchisors must clearly communicate their expectations regarding goods and services to franchisees as early as possible. This information is typically provided to prospective franchisees in Item 16 of the Franchise Disclosure Document (FDD) during the franchise sales process.
This article will outline the information that must be disclosed in Item 16, ensuring that potential franchisees understand what they are allowed to sell in their future business.
Under the federal Franchise Rule, franchisors must disclose “any franchisor-imposed restrictions or conditions on the goods or services that the franchisee may sell or that limit access to customers.” According to 16 C.F.R §436.5(p), disclosures in Item 16 must cover the following:
Any requirement for the franchisee to sell or offer only goods and services that have received approval from the franchisor.
Any requirement for the franchisee to sell or offer all goods and services that the franchisor has authorized.
Whether the franchisor has the right to change the types of authorized goods or services, and if so, any limitations on its ability to make such changes.
FDD ITEM 17 Renewal, Termination, and Transfer
Item 17 of the FDD outlines the terms and conditions for renewing, terminating, or transferring the franchise agreement. This section provides important information about the duration of the franchise agreement, renewal options, and the circumstances under which the agreement can be terminated.
Understanding these provisions is crucial for planning the long-term future of your franchise. By reviewing this section, you can ensure that the terms align with your business goals and provide the necessary flexibility for growth and exit strategies.
Item 17 of the FDD also covers dispute resolution and legal matters. This section outlines the procedures for resolving disputes between the franchisor and franchisee, including mediation, arbitration, and litigation.
Understanding the dispute resolution process is essential for protecting your rights and interests as a franchisee. By reviewing this section, you can ensure that the franchise agreement includes fair and reasonable mechanisms for resolving conflicts.
FDD ITEM 18 Public Figures
In Item 18, the franchisor is required to disclose any celebrities or public figures engaged to promote the franchise system. For franchisors looking to expand their brand, celebrity endorsements aimed at potential franchisees can significantly enhance visibility and prestige during the franchise sales process.
While many franchisors do not rely on celebrity endorsements to sell franchises, it is essential to recognize that any participation from public figures comes with obligations for the franchisor. Franchisee candidates must be informed about the individuals associated with the franchise system, necessitating transparency from franchisors regarding any public figures involved in franchise sales. To comply with federal franchise regulations, this information must be included in Item 18 of the Franchise Disclosure Document (FDD).
For the purposes of Item 18 disclosures, the Federal Trade Commission (FTC) defines a public figure as “a person whose name or physical appearance is widely recognized by the public in the geographic area where the franchise will be located. Item 18 must also disclose any compensation or benefits, including promised compensation or benefits, provided to a public figure for using their name or image in the franchisor's branding or for endorsing the franchise to potential franchisees.
FDD ITEM 19 Financial Performance Representations
Item 19 of the FDD provides financial performance representations (FPRs) if the franchisor chooses to include them. FPRs offer insights into the potential revenue and profitability of the franchise based on historical data.
However, it is important to note that FPRs are not mandatory, and their absence should not be a cause for concern. When reviewing FPRs, consider them as supplementary information and conduct your own due diligence to validate the financial projections.
Item 19 of the FDD allows franchisors to make earnings claims and representations. This section provides insights into the potential financial performance of the franchise based on historical data. However, it is important to approach earnings claims with caution and conduct thorough due diligence. By analyzing this section, you can evaluate the credibility of the earnings claims and assess their relevance to your specific circumstances.
FDD ITEM 20 Franchisee and Franchise System Information
Item 20 provides charts showing growth and owner turnover in the franchisor’s system. If the charts show more than a few franchised outlets in your area have closed, transferred to new owners, or transferred to the franchisor, it could be due to problems with the franchisor’s support or because franchises aren’t profitable.
Current and Former Franchisees
Look for the required disclosure of contact information for current franchisees and franchisees who have left the system during the franchisor’s last fiscal year. Talking to these people may be the most reliable way to verify the franchisor’s claims. Visit or phone as many of them as possible to chat about their experiences. Some current franchisees may be reluctant to talk to you if they’re having problems. If that’s the case, try contacting others on the list.
Some franchisors may give you a separate reference list of franchisees to contact. To ensure you get the full picture, you may want to contact a number of franchisees listed in the disclosure document and some on the separate list. Talk to several franchisees who have been in business just over one year. They’re in the best position to tell you: their total investment
whether they were able to open their outlet in a reasonable time
whether they were satisfied with the franchisor’s training, opening assistance and advertising
whether the franchisor provided ongoing help and assistance
whether they have been able to break even
It’s also a good idea to talk to several franchisees who have been in business for five years. Ask:
how long it took them to break even, earn a reasonable income and recoup their investment
whether the franchisor is providing the services and assistance it promised and fulfilling its contractual obligations
what problems, if any, they are having with the franchisor
whether they would invest in another outlet
whether they’re satisfied with the advertising program
whether they are satisfied with the cost, delivery and quality of goods or services they must buy from the franchisor, its affiliates or sole approved suppliers
It’s worth tracking down former franchisees (using contact information from Item 20), although some of them may have signed confidentiality agreements that prevent them from talking with you. Prior owners can tell you:
the problems they had with their outlet
whether they broke even or made a profit
when and for how long they operated the outlet
their business background
why they left the franchise system
Some franchisors may buy back failed outlets and list them as company-owned outlets. If you’re thinking about buying an existing outlet that the franchisor acquired from a prior franchisee, ask to see the financials showing the outlet’s actual operating results. The franchisor must tell you who owned and operated the outlet for the last five years.
If a franchise has had several owners in a short time, perhaps the location isn’t profitable or the franchisor hasn’t supported that outlet as promised. Contact as many of the previous owners as possible to learn about their experience operating the outlet that failed.
Franchisee Associations
Associations of a franchisor’s franchisees are an important source of information. Franchisors are required to list in the FDD the associations they sponsor or endorse and independent associations that ask to be listed.
An association, whether it’s sponsored, endorsed or independent, can provide information about the relationship between the franchisor and its franchisees. You may want to ask members of a franchisee association about:
the kinds of system problems or issues they discuss
system problems they successfully resolved
any problems franchisees face in the operation of their outlets
any problems franchisees have with the franchisor
FDD Item 21 Financial Statements
Item 21 provides the franchisor’s three most recent audited annual financial statements. If you know how to read financial statements, this information will give you a good understanding of the franchisor’s financial health. If you don’t, it’s a good idea to hire an accountant to review the statements and explain them to you.
Investing in a financially unstable franchisor is a significant risk; the franchisor may go out of business or into bankruptcy after you have invested your money. An accountant can help you understand whether the franchisor:
has steady growth
has a growth plan
makes more of its income from royalty payments from successful existing franchisees or from the sale of franchises
devotes sufficient funds to support its franchise system
FDD ITEM 22 Contracts
In Item 22, the franchisor is required to list and attach all contracts that franchisees must sign with them as an exhibit. This includes a sample of the standard franchise agreement and other related contracts such as a development agreement, site selection agreement, release agreement, and more.
Transparency is essential during the franchise sales process, particularly regarding legal agreements.
Item 22 of the Franchise Disclosure Document (FDD) aims to help potential franchisees understand the contracts they will need to sign when acquiring a franchised business. By allowing candidates to review the proposed legal agreements related to the offered franchise opportunity before making an investment, franchisors enable prospective franchisees to make more informed business decisions.
FDD ITEM 23 Receipts
In Item 23, the franchisor is required to include two copies of the receipt page. This receipt page is a document that a franchisee must sign to acknowledge the proper disclosure and delivery of the Franchise Disclosure Document (FDD).
Compliance with federal franchise regulations is essential during the franchise sales process. According to the federal Franchise Rule, franchisors must provide prospective franchisees with a copy of the FDD at least 14 calendar days before they sign a franchise agreement or make any payments related to the franchise sale.
This two-week disclosure period is designed to give franchisees ample time to review and consider the information in the FDD before making a purchasing decision.
Required Preamble
As stipulated in 16 CFR § 436.5(w)(1), the receipt page in Item 23 must prominently feature
the title “Receipt” in bold. Below this title, the following mandated preamble should appear:
“This disclosure document summarizes certain provisions of the franchise agreement and other information in plain language. Read this disclosure document and all agreements carefully.
If [Name of Franchisor] offers you a franchise, it must provide this disclosure document to you 14 calendar days before you sign a binding agreement with, or make a payment to, the franchisor or an affiliate in connection with the proposed franchise sale.
If [Name of Franchisor] fails to deliver this disclosure document on time or if it contains false or misleading information, or a material omission, it may violate federal and state laws, which should be reported to the Federal Trade Commission, Washington, D.C. 20580 and [State Agency].”
Item 23 Disclosures
In addition to the mandatory preamble, the franchisor must also provide the name, phone number, and business address of each individual selling the franchise to the prospective franchisee. This could include sales representatives, brokers, sub-franchisors, and others. Since each franchise situation varies, it’s advisable for franchisors to consult with an experienced franchise attorney to determine which individuals should be disclosed in Item 23.
The franchisor must also include the date the FDD was issued (or its “effective date”).
Following these disclosures, the receipt page must contain the statement: “I received a disclosure document dated __________ that included the following Exhibits:” This statement should be followed by a list of all exhibit titles attached to the FDD. There should also be space for the prospective franchisee’s signature and the date of signing.
Lastly, the franchisor may include instructions for how the receipt page should be returned, such as providing an email address, mailing address, or another method. An electronic option, such as a web page, may also be offered at the franchisor’s discretion.
Due Diligence and Professional Assistance
When reviewing the FDD, it is essential to conduct thorough due diligence and seek professional assistance. Engage with experienced franchise attorneys and consultants who can provide valuable insights and guidance. They can help you interpret the FDD, identify any red flags, and negotiate favorable terms. By conducting due diligence and seeking professional assistance, you can make informed decisions and mitigate potential risks.
Conclusion
In conclusion, the Franchise Disclosure Document is a vital tool for anyone considering a franchise opportunity. It provides comprehensive information about the franchisor, fees, obligations, and more.
By thoroughly reviewing the FDD and seeking professional assistance, you can make
informed decisions and increase your chances of success in the franchise industry. Take the time to understand the FDD and leverage it to your advantage. Remember, knowledge is power when it comes to franchising.
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