Navigate the Paper Trail

Key Items In the FDD

Not all the information in the FDD is enlightening or particularly useful, but you can dig out much that is. Look for this key information as you read:

  • Item 2 describes the business background of the officers, directors and managers of the franchise company. Scan these summaries to get an idea of their experience.
  • Item 3 summarizes the litigation background of the franchisor and the people listed in Item 2. If there have been actions taken by state or federal enforcement agencies, or if private lawsuits relevant to the franchise system have been filed against the franchisor in the past 10 years, they are summarized in this section. If you find a significant number of actions, especially where franchisees have sued the company, make a note to investigate further.
  • Item 4 lists any bankruptcies in the backgrounds of either the franchisor or the people listed in Item 2.
  • Items 5 and 6 summarize the initial franchise fees, ongoing royalty fees and other charges franchisees must pay. If the initial fees have been negotiated in the past year, that will be disclosed in Item 5.
  • Item 7 presents the franchisor's estimate of the typical total investment by the franchisee, in chart form. You will need this key information when you prepare your own business plan or seek financing for the franchise. Be sure you review this information with your accountant.
  • Item 8 discloses the restrictions placed on the franchisee's purchase of supplies and product inventory for resale in the franchised business. It also presents information about rebates generated by franchisee purchases and the portion of the franchisor's revenue that comes from purchases made from the franchise company. If it looks like most of the franchisor's revenue comes from franchisee purchases, find out from other franchisees if products are fairly priced and effectively delivered. Supply arrangements are a vital aspect of running a franchise, so make sure the system works well.
  • Item 10 discusses financing. Many franchisors either provide financing to franchisees or make special arrangements with banks or other lenders to assist franchisees. Even if there is no mention of special financing arrangements in this item, ask the franchisor about them.
  • Item 11 , the longest section in the document, highlights the franchisor's obligations to the franchisee under the franchise agreement. It also describes required computer equipment purchases and the initial training program.
  • Item 12 explains territorial rights. Make sure you understand exactly what rights you have, both inside and outside any designated territory. If the franchisor reserves the right in this item to distribute competing products or services through other channels of distribution, find out what this means and how the company intends to use that right.
  • Item 13 reveals details about the trademark licensed to franchisees. Is it federally registered or is registration pending? If it isn't effectively registered, the franchisor--and you--may have problems with it down the road.
  • Item 19 reveals earnings claims. This key section shows what kinds of sales or profits other franchise owners have made, if the franchisor chooses to supply the information. Most don't. If a franchisor does provide this information, it must also provide data to prove the claims upon your request. If no performance information appears here, find out why. It may be because the performance of franchisees does not paint a very attractive picture, or it could simply be that earnings vary widely from one region to another or one franchisee to another. Ask franchisees about their sales and profits; most are happy to share their experiences.
  • Item 20 contains systemwide statistical information, such as how many new businesses have opened over the past three years and how many franchise owners have left the system over the same period of time. This section also contains a list of the names, addresses and telephone numbers of current franchisees and those who have left the system in the past year. Call them.

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