Mastering the Art of Evaluating Franchise Disclosure Documents
Franchising is a popular and lucrative way of starting and running a business without the hassle of building a business model from scratch. However, before getting into any franchising agreement, it is crucial to conduct thorough research on the business model, the owner, and the franchise disclosure document (FDD). The FDD contains essential information for potential franchisees, including fees and costs, obligations, and rights within the franchise agreement, as well as risks associated with the business.
As a potential franchisee, one needs to conduct a critical evaluation of the FDD to make an informed decision about the franchise opportunity’s viability. A successful evaluation of the FDD involves a series of critical steps, including but not limited to, the following:
- Disclosure Requirements: Franchisors are mandated to disclose critical information in compliance with the Federal Trade Commission’s (FTC) Franchise Disclosure Rule. The information disclosed covers many aspects of the franchise, including the franchise agreement, ownership, the ongoing support system, and the franchisor’s financial standing. With a minimum of 23 items to review, it is essential to study each item in detail to make informed and accurate decisions.
- Fee Structure and Financial Requirements: The FDD should detail all the costs and fees required in starting and running the franchise. From the initial franchise fee to any additional training or ongoing royalties, knowing the full costs assists in creating a business plan for revenue growth in the long-term. Additionally, financial requirements such as net worth, liquidity, or a clear business plan can help determine the investor’s suitability for the franchise opportunity.
- Litigation and Potential Conflicts: The FDD must also disclose information on any lawsuits, disputes, or potential conflicts that the franchisor has been a part of in the past. Understanding any potential conflicts can help the franchisee prepare to handle any arising disputes in the future.
- Speaking to Other Franchisees: One way to conduct effective due diligence is to speak with other operating franchisees within the network. It is essential to ask direct and specific questions on how the franchise operates and the level of support they receive. A one-on-one conversation with a current franchisee will give a clear understanding of the franchise model from a different perspective, aiding in the decision-making process.
- Seek Expert Advice from a Franchise Attorney: Evaluating an FDD can be complex and daunting; thus, investing in a franchise attorney can help one interpret and translate the FDD’s legal terms in understandable layman’s terms. The franchise attorney can also assist in negotiations and provide insight into specific clauses, thus protecting the franchisee before entering into the franchise agreement.
Evaluating a Franchise Disclosure Document is a crucial step towards making an informed decision about starting or investing in a franchise. A critical review of the FDD will enable a potential franchisee to identify any red flags, conduct effective due diligence, and make the most informed decision. By engaging in a thorough evaluation process, a potential franchisee is investing in their future and setting themselves up for success in the long term.