Running a franchise comes with a lot of risk and responsibility. To make sure you fully understand the risks involved, franchisors are legally required to provide you with a Financial Disclosure Document (FDD) at least 14 days before you enter into a franchising agreement. These documents will include most of the information you need to know to decide whether or not buying the franchise is a good choice.<\/p>\n\n\n\n
However, FDDs can often cause more confusion than they resolve. And if you\u2019re new to franchising, you might not know which red flags to keep your eyes peeled for. In this guide, I\u2019ll explain how to properly read an FDD. You\u2019ll find out about the type of information included, where you\u2019ll find it, and some common warning signs to look out for.<\/p>\n\n\n\n
Up until a few decades ago, the lack of regulation in the franchising industry made it a hotbed for scammers. So, to prevent franchising scams from taking place on such a large scale, the Federal Trade Commission (FTC) implemented what became known as the FTC rule in 1978<\/a>. This law requires franchisors to provide potential franchisees with a Financial Disclosure Document<\/a> (FDD)<\/a> at least two weeks before signing the Franchise Agreement<\/a> or paying any fees.<\/p>\n\n\n\n The purpose of the FDD is to provide you with enough validated and vetted information about the franchisor to make an informed decision about whether the franchise is worth your investment<\/a> before you enter into a franchise agreement. Before buying a new franchise<\/a>, you need to review the FDD with a fine-toothed comb, ideally with an experienced franchising expert. <\/p>\n\n\n\n Depending on the franchise, the FDD may be over a hundred pages long and will include a lot of information. Go in blind and attempt to read the FDD without any prior franchise knowledge, and you are bound to miss some things. An FDD typically contains at least 23 distinct sections (or items), each serving to provide answers to specific questions about the franchising opportunity. Below, I\u2019ve grouped some of the most important items with the key questions they answer.<\/p>\n\n\n\n One of the most crucial questions the FDD answers about a franchise is the total cost of the investment. You obviously shouldn\u2019t purchase a franchise without thoroughly understanding how much it will cost.<\/p>\n\n\n\n In addition to the initial franchise fee<\/a>, the FDD should provide details on costs such as ongoing royalty fees<\/a>, renewal rates, advertising contributions, and any other costs that may arise during your tenure as a franchisee.<\/p>\n\n\n\n Here\u2019s where you\u2019ll find more information about franchise costs in the FDD.<\/p>\n\n\n\n This section details the initial fees associated with becoming a franchisee, including the franchise fee, supplies and materials, and any applicable multi-unit fees.<\/p>\n\n\n\n Here, you\u2019ll discover information about ongoing costs such as royalty, marketing, renewal, training, and technology fees.<\/p>\n\n\n\n Item 7 gives you a realistic estimate of how much it will cost in total to open a franchise<\/a>. It combines the initial investment fees covered in Item 5 with estimates for signage, IT infrastructure, lease deposits, insurance fees, grand opening expenses, and any other fee that will contribute to the total cost of your initial investment.<\/p>\n\n\n\n Investors are often attracted to franchising because it allows them to capitalize on the reputation of a well-known brand while utilizing a proven, successful business model. Another major benefit of franchising is that you\u2019ll generally receive ongoing support from the franchisor to mitigate risks and maximize the chances of business success. You should expect to receive some level of support from your franchisor in return for your ongoing royalty payments. However, the amount of support you\u2019ll get varies significantly depending on the parent company. So, carefully read through the following FDD items to find out what type of support your potential franchisor provides.<\/p>\n\n\n\n Item 8 details your suppliers for materials and inventory, which is especially crucial if you intend to operate a franchise in the fast-food or restaurant industry<\/a>.<\/p>\n\n\n\n This section summarises the ongoing assistance you\u2019ll receive through training and operational procedures as a franchisee.<\/p>\n\n\n\n Here, you can discover how your franchisor defines a territory and allocates territorial rights.<\/p>\n\n\n\n Check Item 14 to learn more about the franchisor\u2019s intellectual property and copyrights.<\/p>\n\n\n\n Lastly, Item 15 details franchise renewal fees, termination grounds, dispute resolution procedures, and transfer options.<\/p>\n\n\n\nHow to Read and Review an FDD<\/h2>\n\n\n\n
How Much Does the Franchise Cost?<\/h3>\n\n\n\n
Item 5<\/h4>\n\n\n\n
Item 6<\/h4>\n\n\n\n
Item 7<\/h4>\n\n\n\n
Support You\u2019ll Receive From the Franchisor<\/h3>\n\n\n\n
Item 8<\/h4>\n\n\n\n
Item 11<\/h4>\n\n\n\n
Item 12<\/h4>\n\n\n\n
Item 14<\/h4>\n\n\n\n
Item 15<\/h4>\n\n\n\n
Franchisee Obligations<\/h3>\n\n\n\n