Five Items in the Franchise Disclosure Document that Deserve Attention
In addition to certain items in the FDD that receive the bulk
of attention there are five items that should not be overlooked.
There are twenty three items in a Franchise Disclosure Document
and each one deserves varying degrees of attention and analysis.
Some items including Item 2 which describes the business experience
of franchisor staff, Item 3 Litigation, Items 5 and 6 Initial fees
and Other Fees respectively are often mentioned as deserving of
added scrutiny, although each item is important in its own right.
There are five items in the FDD that I consider to be not only
important, but also indicative of the franchisors franchise
philosophy. Each item should be carefully reviewed.
1. Item 7 Initial Investment can contain some financial
information that may not be accurate. Since some franchisors may
understate the estimated investment in order to be attractive to
candidates it can also be a cause for future problems. The
Additional Capital category should be carefully scrutinized since it
only estimates 3 months of additional working capital, which is
fairly optimistic for a start-up business
2. Item 8 Restrictions on Sources of Products and Services will
indicate limitations of what products a franchisee may offer for
sale. It will also indicate the percent of products and services
franchisees purchase from required vendors. The amount of revenues
and rebates franchisors earn from required franchisee purchases must
be disclosed. Look for an amount of franchisor revenues, that is
higher compared to similar sized comparable franchise systems. Be
cautious, that the franchisor is not earning excessive sums of money
from products and services that franchisees must purchase from
3. Item 12 Territory will state whether the territory is
exclusive, protected and defined. The best territory is one that is
exclusive and defined. Be wary of franchisors that offer no
franchisee territory protections or definition.
4. Item 19 Earnings Claim will state whether or not a franchisor
will disclose financial results. Many in the franchise industry
recommend that except for a start-up franchise, any franchisor not
doing an earnings claim should avoided. Itís reported that
approximately 65% of franchisors do an earnings claim.
5. List of Outlets with present in various tables the increase in
franchise and company units for the most recently completed 3 year
period. Look at Sold But Not Opened units to determine if the
franchisor is selling a number of franchises which are not yet
opened. Another table will list franchisee terminations, transfers,
reacquired and ceased operations. The key number, a franchise
candidate should look for, is net franchise growth, which represents
the difference between new franchise units added minus those that
left the system.
Although each item in the FDD is important there are some that
deserve special attention. The above 5 items can reveal a flaw in
the franchisorís operating philosophy. A franchisor that earns a
substantial amount of revenues from franchisee purchases, grants an
unprotected and undefined territory, makes no earnings claim and has
negative net unit growth ought to be avoided. Remember, to compare
data from comparable systems.
© 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