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One Item in the FDD Can Say a Lot about the Franchisor

by Ed Teixeira

Learn why Item 20 in the Franchise Disclosure Document can provide a wealth of information about a franchisor and its franchise program.

There are certain routines that prospective franchisees and their advisors follow, when considering a franchise opportunity. The source documents that are most important are the Franchise Disclosure Document and franchise agreement. A review of these documents, in addition to interviews with current and former franchisees, typically represents the foundation of a franchise program evaluation.

One Item in the FDD, namely Item 20, can tell a lot about the franchisor and its' performance. However, in many cases, this Item doesn't receive the scrutiny it deserves. There is the obligatory review of certain tables and entries but it's been my experience that a good deal of information remains unknown.

There are five tables in "Item 20 Outlets and Franchisee Information" and each one present's specific information. Here is a brief description of each table and what to look for.

  • Table 1: The System-Wide Outlet Summary presents the number of franchised and company owned outlets and the net change, for a 3 year period. It shows the number of outlets at the start of each year and the end of each year with total outlets and net change for each year. Look for trends in this Table, such as increase in number of Company Owned locations which could indicate a trend towards more Company Owned locations and less franchisee owned. Look for trends and changes in the total number of locations for each year.
  • Table 2: Transfers of Outlets from Franchisors to New Owners (other than the Franchisor) presents the number of transfers from franchisees by state for a 3 year period. This table can provide insight into potential positive or negative signs. A mature franchise program can experience an increase in transfers when some franchisees decide to "cash out." It might also mean that franchisees seem problems in the future and are looking to exit the franchise program. Look for trends and potential red flags but remember an increase in transfers may not be a negative.
  • Table 3: Status of Franchise Outlets presents by state; the number of outlets at the start of each year for a 3 year period , number opened, terminated, non-renewed, reacquired by franchisor and ceased operations for other reasons and the number of outlets at the end of the year. This is one of the more important Tables since it can reveal negative trends. A large number of terminations and ceased operations can point to a flawed or failing franchise program. In addition, franchisor acquisitions could represent a situation where there is dispute between the parties and rather than litigate and have to disclose that in the FDD the franchisor pays the franchisee a token sum of money to acquire the franchise. Look for trends in this Table and if some appear be sure to investigate the reasons. When franchise terminations and ceased operations go over 5% of total franchisee locations, it can be a danger sign.
  • Table 4: Status of Company Owned Outlets is shown as a total for a 3 year period. Look for any trends representing a large increase in company owned outlets since it could indicate a de-emphasis of the franchise program. A decrease in company owned outlets is usually the result of the franchisor re-selling company owned units.
  • Table 5: Projected New Franchised Outlets for the latest year is a mixed bag of information. This Table shows projected new franchise and company owned outlets by State. In a number of cases a franchisor might project new outlets without a significant amount of research behind the numbers. The most important entry is under Franchise Agreements Signed but not Opened commonly referred to as SBNO. If there is a large number in this section it could indicate that the franchisor is more focused on selling new franchises rather than helping to grow and develop the existing system. Once again look for red flags.

The Franchise Disclosure Document contains a wealth of information and Item 20 in particular deserves focus. Each of the tables in Item 20 contains important insight into the franchise operation.

2015 FranchiseKnowHow, LLC

Ed Teixeira is the President of FranchiseKnowHow.com and Chief Operating Officer, FranchiseGrade.com. He is a former franchise executive and franchisee. He can be contacted at 631-246-5782 or at  franchiseknowhow@gmail.com

 

 

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