(FS6) Reading a Franchise FDD – Cover Page to Item 23

The Cover Pages of the FDD

Every formal document will always start out with a cover page. On this (these) page(s) you should look forward to this information:

Summary of the franchise’s offerings and initial investment required.
State that no government agency has verified the information in the document.
Remind the franchisee to read the entire document carefully, including accompanying documents.
Suggest the franchisee show the FDD and other documents to a qualified advisor.
Recommend the franchisee familiarize self with franchising laws.

There should also be a list of risks the franchisee has to acknowledge on the cover page such as:

Laws that Govern the Franchise Agreement: If your franchisor lives outside of the state you plan to put your store, familiarize yourself with the franchise laws that are exclusive to the state of the franchisor’s home-state because they can choose to use their rules and not yours. While some states allow this, some do not.
Where Franchisee May Sue Franchisor: If there is ever a problem between the franchisee and the franchisor, the law may require the franchisee to sue the franchisor in their home state. All the expenses will be incurred by the individual fighting the franchisor at this point.
Inclusion of Arbitration as Method of Solving Disputes: That is, the inclusion of whether the franchisee is allowed to sue the franchisor if some issue arises, but they will be able to bring the dispute to an arbitrator.
Information on the Franchisor’s Financial Situation: This includes the franchisor’s audited financial statements, past financial misses or gains, and other financial information that may change how secure the franchisee feels about the franchisor.

Reminder: Just because the FDD has been filed with the state does not mean that the information has been verified. As the franchisee, you should read carefully and continue to do research to make sure the information meets where it says it does.

Now that we know what to expect on the cover page, let’s hit the rest of the document.

Item 1: The Franchisor, its predecessor, and its affiliates

Item 1 contains a description of the franchise and what it offers written by the franchisor. Information required by law for item 1 includes:

Franchisor’s address
Name of Franchise, it’s parents, predecessors, and affiliates
Name under which the franchise does business
Prior business experiences the franchisor, its predecessor, and its affiliates have
The franchisors state of incorporation or the franchise’s type of business organization
Type of business (or businesses) offered by franchisor
Any information that relates to governmental regulation in the franchisor’s industry

Item 2: Business Experience

Item 2 contains a biography and all personal information about the franchisor and its staff (officers, directors, executives). This is to allow franchisees a chance to learn about who they are getting into business with.

Item 3: Litigation

Item 3 should provide the last ten years’ worth of litigation information that has been filed with the franchisor. It should also contain specific information on any cases filed within the last year against any of its franchisees.

The purpose of item 3 is to give franchisees insight into what the franchisor-franchisee relationship looks like with this particular company. You should find cases filed by the franchisor for royalty or fee collections issues against the franchisee. You should also be able to find any case files for charges against franchisees who haven’t been following the “system standard” set by the franchisor. This will only be a one-year snapshot, but this item will give franchisees an insight into the franchisor’s practice of initiating litigations.

Item 4: Bankruptcies

If your franchisor or any members of their management team have ever gone through bankruptcies and if they have, when it was. This gives franchisees a chance to find any patterns of bankruptcy among the management staff who they are preparing to have a relationship and whether that pattern is predictable or not.

Item 5: Initial Franchise Fee

Every franchisee is looking for this to make sure it fits where their budget. The FDD should disclose the complete franchise fees for the initial cost that is anything prior to opening, and exactly what they are. If they cannot give an exact cost, they should give a pretty clear range that can be expected.

Item 6: Other Fees

There are more fees to franchising than the initial fee. Item 6 should contain a list of other fees that the franchisee can expect to be charged for in the duration of the relationship. These fees can be things like:

Royalties: This is the continual fee you can expect to pay annually in order to use the franchisor’s trademarks and system.
Contribution from the franchisee to help with the advertising system the franchisor has in place.
Requirements that the franchisee participate in local or regional advertising.
Training fees.
Service or benefit fees the franchisee may have to pay to the franchisor and/or their affiliates.
Transfer fees if purchasing an existing franchise.
Audit fees or costs when the franchisor audits the franchisee’s books and records. Franchisees will also have to pay for any discrepancies found.
End-of-term fees for continuing the relationship or contract into a new term (renewal fees).

Item 7: Initial Investment

This is different from item 5 in that it tells you more than the initial fee. It provides the franchisee with a table that includes all expenditures on the franchisee’s part in order to establish the franchise. There will a range from the most minimal of needs to more expensive packages. This section will also list accepted methods of payment to the franchisor, a calendar of when payments are due, who to send the payment to, whether it’s refundable or nonrefundable, and if financing is available.

There are typically notes written along with each of the fees listed to help franchisees understand everything clearer. If you do not understand something, take it to someone who can explain it to you as it’s important to understand everything in the FDD 100% before making a decision.

Item 8: Restrictions on Sources of Products and Services

Franchisors typically have pre-decided services and products that they are known for. Think of the brands you see in pet stores or how Dairy Queen only offers their signature food. Regardless of the industry that you enter, this section will list the suppliers that are purchased from and what supplies are available to the franchisee. You may not be required to purchase all supplies or to offer all services listed here as some franchises are bigger than others. Whatever your franchise is required to offer in the way of services or products will be listed here. If you have anything that deviates from the list, you will be required to receive permission from your franchisor before you can offer it.

Some things to know about franchisor products and services:

The franchisor may be your only supplier.
The franchisor may earn income from the franchisee’s purchases.
The franchisor can not only set who the franchisee is allowed to purchase supplies from, but what the minimal purchases must be.
Information on any supplier corporation that the franchisor uses.
Any ownership interest any of the suppliers have in the franchise system will be noted.

Item 9: Franchisee’s Obligations

In item 9 will contain a reference table where franchisees will find any obligations they are required to fulfill. The list will also contain information on where else you can find information on obligations in the FDD and in the franchise agreement. The details of the obligations are usually not discussed in item 9. Note that not all franchisees in the same system or company will have the same obligations, just like they will not all have the same exact store.

However as you’re looking over the franchisee obligation section, here are some things you can expect to see:

A list of records that the franchisee must maintain and report to the franchisor
Advertising requirements
Fees the franchisee agrees to pay
Information on trademarks and proprietary provided by the franchisor
Initial and ongoing training the franchisee will receive and what is required vs. optional training
Inspection and audit rights of the franchisor
Insurance requirements
Methods to solve disputes between the franchisor and franchisee
Noncompetition covenants limiting the franchisee’s ability to go into a similar business with unaffiliated franchises after their relationship ends
Ongoing product/service purchases
Opening requirement such as how much time the franchisee has to open the business and operations
Other obligation of the franchisee specific to the franchisor
Owner’s participants in operation including management and staffing of the locations
Post-termination obligations of the franchisee
Pre-opening purchases and leases
Renewal requirements
Requirements for maintenance, appearance, and remodeling
Site development and any pre-opening requirements
Territorial development, sales quotas, and other business-related requirements the franchisee must meet
The definition of the franchisor’s and franchisee’s obligations or duties as pertains to compensation for losses, damages, or injury sustained through actions with the other
Transfer requirements
Warranty and customer service requirements
Site selection and acquisition fees

Item 10: Financing Available

Item ten will show any financing assistance that may be available to the franchisee through the franchisor’s system or what other franchisees have done. This item will also list all the terms and conditions for any listed financial arrangements available. The financing assistance options may be organized by purpose such as startup cost, operations, equipment, etc.

Item 11: Franchisor’s Obligations

Just as was done for the franchisee, the franchisor’s list of obligations to you will also be in the FDD. Some of these obligations may be, but are not limited to, the following:

A table of contents for the franchisor’s manual
Before and after business opens care for the franchisee
Franchisor’s advertising program specifics including media type, the cost, what part they pay and what part you pay, and any other information regarding campaigns
Franchisor’s training program and all applicable information such as duration, outline, experience of instructors, charges, cost and person responsible for paying, what is mandatory, and whether there is continual or refresher training required
Generalized description of computer and technology used for cash handling or running of the business
Methods which the franchisor may use to select a location
The typical amount of time between signing the franchise agreement and opening the franchise

Item 12: Territory

Not all franchises have strict rules about territories, but they should all have provisional information. Item 12 should usually contain the following information:

Description of any exclusive territory
Information regarding whether the franchisor has established another franchise or company in a specific area
Methods the franchisor may use to resolve conflicts regarding territory
Whether a certain territory is protected and if so, for how long
Whether the franchisor holds specific rights to make sales over the internet, through catalogs, or telemarketing
Whether the territory is conditional i.e. if you must make a certain sales goal in order to work that specific area

Item 13: Trademarks

Item 13 will discuss any trademarks the franchise has through services, marks, trade names, and trademarks.

Item 14: Patents, Copyright, and Proprietary Information

Item 14 provides franchisees with information regarding patents the company holds along with any copyrights. You’ll also learn about how they are used and how to apply for more.

Item 15: Obligations of Operation for the Franchise Business

These are the special terms and conditions apply to franchisees based on the individual franchise. Some will allow the owners to be absent from the location in order to run it while others will require full-time involvement at all times. That information will be under item 15.

Item 16: Restrictions on What the Franchise May Sell

This item talks about restrictions on the goods or services that you may offer to your consumers specifically.

Item 17: Renewals, Terminations, Transfers, and Dispute Resolutions

Every franchise, franchisor, and franchisee will have slightly different way to deal with all of the above listed things. What you can expect to find in this section is:

In-term and out-term restrictions on working with competing franchises
Legitimate reasons the franchisor or franchisee may use to terminate the agreement, the causes, and any cure period there may be
Methods for resolving disputes between the franchisor and the franchisees through: litigation, arbitration, and mediation.
Number and duration of renewal periods
Obligations of the parties after termination
The length of the initial term or agreement
The rights of the franchisor or franchisee as pertains to transferring franchise ownership
The rights the franchisor has to purchase the franchisee’s business
Ways in which franchise agreements can be modified
What you will have to do in order to renew your franchise agreement and what a renewed agreement may look like

Item 18: Public Figures

This item refers to any celebrity endorsement or public figures that may recommend the product or services or stand as a symbol for the franchise. The rules listed here will be things such as pay, extent to which the public figure may perform or be involved with management and the franchise system, and the public figures total investment in the franchise.

Item 19: Financial Performance Representation

This item will include information on levels or range of sales and sale potential, costs, income, and profit for franchise or non-franchise locations. The franchisor may also provide financial performance information relating to the subset of its units.

Item 20: List of Franchise Outlets

Item 20 will inform the franchise on locations operations that are part of the system such as:

Names, addresses, and telephone numbers of franchises
Number of franchise transfers, cancellations, or terminations
Number of franchises and company-owned locations in each state.
Number of franchises closing or ceasing operation
Number of franchises not being renewed or being repossessed by the franchisor
Projected franchise sales for the next year
Summary of system-wide growth and franchisee-to-franchisee transfers in each state

By law, a franchisor is required to provide franchisees with the names, numbers, and addresses for the most recently franchisee or outlet who was terminated, canceled, or did not renew. The franchisor must also present the franchisee with any confidential agreements that have been signed by franchisees within the past three years.

If you’re interested in purchasing a franchise owned directly by the franchisor, you should expect to receive contact information for each of the owners over the last three years.

Item 21: Financial Statements

Item 21 should include financial statements from the last three years or shorter time gaps if the franchise has not been running for that long. There is a specific way these documents must be prepared according to the GAAP. Foreign franchisors may also submit their financial information through the Securities and Exchange Commission (SEC). If a startup franchisor doesn’t have audited financial statements available, they are able to phase their audit over the period of three years. However several states still require startup franchisor’s present financial statements with their FDD.

Item 22: Contracts

This item should list all the agreements and contracts that you will be required to sign as well as any ancillary agreements. Confidentiality agreements, development agreements, and software license agreements should also be listed and explained here.

Item 23: Receipt

You will have to sign a receipt when you receive the FDD. Inside of the FDD, you will find two copies of it in the FDD. They should state the franchisor’s name as well as contact information and any other personnel involved in the transaction. They should also state information on the salesperson who worked with you.