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Five Items in the Franchise Disclosure Document that Deserve Attention

by Ed Teixeira

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 specific vendors.

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 at  franchiseknowhow@gmail.com

 

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