If you’re reading this article, you probably have some interest in owning an EatGatherLove franchise. That being the case, you’re going to want to become familiar with one of the most important parts of the due diligence phase of the process – the FDD review. The following is the “Reader’s Digest” version of the legal part of the process – the basics.
To start with, let’s make sure you understand the basics.
First, each franchise company in the USA is required to produce a Franchise Disclosure Document, better known as an FDD. This is a Federal Trade Commission rule and some states even have extra rules franchisors have to adhere too. These are called ‘registration’ states. EatGatherLove will tell you if you’re in a registration state.
Next, each FDD follows a set format, which makes it really easy for you to compare each company’s offering. This format is broken down into “Items”. So, for example, the Item 7 in each company’s FDD would be the section where they lay out how much the total investment will be for the franchise and what you’re paying for. If you compare Wendy’s Item 7 to McDonald’s Item 7, they’ll each show details of the same info. Handy, right?
What to look for?
- Start with the company info. Each major leader in the company is required to list their background and last 5 year’s work history. While you’ll usually find that the founders have tons of experience in the industry that the franchise serves, you want to make sure that there is strong support from the franchising industry as well. It’s not enough that they understand just how their industry works. They must also have experience selecting the right franchisees and providing support to their franchisees.
- You’ll also want to look for any bankruptcy issues from the senior team. It could be that they just had some bad luck but you can and should inquire so you can make sure it’s not a repeating theme.
- Franchisors are also required to list any material litigation pending or past as this too could be a sign of an unstable franchise.
- Skipping ahead a bit, you’ll see that a copy of the financial reports are attached. If you’re not adept at reading this information, take it to your accountant and ask for their opinion on the company’s financial health.
Now, about those “Items”
While you surely want to read the entire FDD, there are several areas in the offering you’ll want to pay close attention to:
- Items 4-5-6. This is where they’ll list all the expenses associated with running the business. Pay close attention to this and start making some financial projections of your own on the business. Ask the company if they have a blank spreadsheet formatted to their concept to save you some time.
- Item 7 – The ‘Total Investment’. It’ll likely be a rather broad range to account for any unusual situations. Make sure you ask their franchisees what they spent so you won’t have any surprises as you go through your own opening process.
- Item 8 – Restrictions on products you use in the business. This is where they’ll tell you about any products or services they require you to use, and whether they make a profit on your use of them. Make sure these items are reasonable and customary to the operation and that you’ll be paying the same or less than what you’d pay if you were an independent operator.
- Item 19 – The big one! This is where the franchisor can make a FPR – Franchise Performance Representation. In fact, this is the ONLY place they can make any kind of earnings claim. If a franchisor makes a claim that’s not in this Item 19, they could be committing franchise fraud, so you’ll find that reputable franchisors are very careful about how they present financial performance. Usually historical, FPR’s come in many shapes and sizes. Some franchisors rollup results from a large group of stores, some break the data down into high-medium-low performing groups. Regardless of how they do it, you should devote a big chunk of your time getting familiar with this data and using it as a benchmark to compare against when you start talking with their franchisees. It’s too easy to believe the “hype” of a franchise and forget that the numbers MUST make sense.
- Item 20 – Franchise growth over the past few (minimum 3) years. This is a great indicator of how well the existing franchisees are doing. If a large portion of stores have closed, you’ll see that here. Also, if a large number of stores have been transferred or reverted to “company owned”, that may be a sign that the franchisor has been struggling and took over stores it couldn’t support.
It’s important to note that the wording throughout the document will be written heavily in favor of the franchisor. Should this be a concern? Naturally, you don’t want to sign a document that’s unfair, but this is an area where franchising simply differs from many other types of legal arrangement. Because you’ll be sharing the franchise company’s brand with many other franchisees, they – the franchisor – must have a strongly worded document that allows them to quickly take action against a bad operator. You want them to be able to protect the common name you all operate under. After you get a look at a number of FDD’s, you’ll see that they all have pretty strongly worded language, especially when it comes to protecting their brand.
Should you hire an attorney to review the FDD?
By all means, EatGatherLove recommends you do, it pays to have a professional review of the document for you. BUT, make certain your attorney is a franchise industry attorney. It’s a highly specialized area of law and not something an outsider will easily understand. And paying an outsider to get up to speed is not money well spent. Franchisors are required to give you the FDD at least 2 weeks before you can sign a franchise agreement but don’t hesitate to ask for it as soon as possible so you can do your homework. Once you’re fluent on the legal side of things, you’ll want to start your validation process. Only by doing your homework can you be well informed enough to make a decision about a franchise. Ask lots of questions, takes lots of notes, and be diligent in your pursuit of a franchise and you’re much more likely to make the right decision.