Becoming a franchisee is an exciting step. Some folks jump into it late in life, having learned from past successes and failures. While others are fresh-faced entrepreneurs, confident in their know-how and ready to take that knowledge to market. Regardless of where one falls, there is one document that is paramount before making that franchisee leap. And that document is the Franchise Disclosure Document (FDD).
There is a lot of information to absorb from this document. First up – the brand’s history. You’re plucking down some hard-earned cash so having pertinent information surrounding the brand, how many times it’s been bought and sold, background on the people who have been running the company, changes in ownership, etc… This is where you get an overall, macro-level understanding of what you’re getting into.
Think of a franchise like an extended family, and as with any family, there could be past conflicts worth knowing about. The FDD will detail any litigation they’ve been involved in over the last five years and cue the red flags if you see pending class actions, suits for fraud or even misrepresentation. In conjunction with litigation, bankruptcy, if relevant, will also be detailed in the FDD.
Item 7 of the FDD is an interesting one – estimated initial investment. A good rule of thumb is take the number and compare across the same industry standard – fast food with fast food, casual sit-down with casual sit-down. $750,000 might be a steal in the casual sit-down arena but completely unworkable for a fast food joint. Diving deeper into financials, Item 21 (the Financials) is a must read.
“Is the franchisor making most of its money off existing royalties?” “Or do they rely on the consistent sale of new franchises?” The former is a healthy sign while the latter could indicate problems. Item 19 is voluntary – what franchisees can expect from sales and profits. Because this is voluntary information, really key in on what they’re providing. Revenue numbers are great but certainly don’t tell the whole story. Ideally, the franchise will detail gross margins. A section of the FDD that might seem unimportant is “Restrictions on Products and Services.” This section is actually very important as it communicates items such as whether you must purchase products from an affiliate of the franchisor. If so, you could find yourself squeezed into paying above market prices for products because said affiliate knows you’ve been roped into this deal.
The FDD contains a wealth of information and is the most transparent and useful document for anyone looking to learn more about a particular franchise.