Buying a franchise is a huge ‘leap forward.’ For most people, it will likely be the second biggest investment next to purchasing a home.
Thanks to our government and the Federal Trade Commission (FTC), franchisors must disclosure to you a copy of their pre-sale Franchise Disclosure Document (FDD) and a copy of the Franchise Agreement (only sign if and when you are awarded a franchise). The FTC is trying to protect you. The best protection is for you to do your complete and thorough due diligence.
The total document will be about the size of a phone book (if you can recall what they looked like when phones hung on walls).
Don’t get anxious when you receive the FDD and the franchisor asks you to sign a ‘Receipt Page’ or Item 23 in the document. The FDD is an information document and is not a legally binding document. Signing, dating and returning Item 23 to the franchisor does just that – acknowledges that you received the document from the franchisor.
The date is important, because if you are awarded a franchise, the FDD must have been in your hands at least 14 calendar days prior to signing a franchise agreement.
In the franchise discovery process, most franchisors will send you the FDD after you have completed some type of questionnaire or application. Today, you will most likely receive it via email as a PDF attachment or in a digital format. You can also request the document be sent to you in print format.
It’s important that you read the entire document cover to cover, but there are a few Items that should have a weighted-value.
Let’s review a few of them:
- Item 7 – The Initial Investment. Does the total investment fall within your financial wherewithal? You will see a range of a low investment to a high investment and usually that is a large spread. The key is to find out what the common ‘sweet spot’ is for starting and opening your new franchise.
- Item 19 – Financial Performance Representation. Now that you have some idea of what it will take financially to get started, why not look at how much money you can make with this franchise. Go to Item 19. Most Item 19’s will not give you net income returns, but more than likely will report historical gross sales within the franchise system and maybe gross margins. It’s a good starting point. To get a much clearer financial picture of how much money you can make is best done when you reach out to existing franchisees when you are at the validation step.
- Item 20 – List Of Franchise Outlets. The franchise system may be large or small as far as units, but there are some hidden gems in this section that will indicate the ‘vital signs’ of the system. This section is laid out in a few tables. Look to see how many units are being added and how many are closing? How many have been sold, but not opened? How many units have been transferred or sold back to the franchisor? Terminated? If any of this information is concerning, be sure to address your concerns not only with the franchisor, but with some of the franchisees – especially those that have been in the system for some time.
- Item 3 – Litigation. This section discloses any prior and pending legal actions against the franchisor – or any civil actions that the franchisor has taken against one of its own; a franchisee. Depending on the size and age of the franchise system, a good rule of thumb might be 3% here. Example, if you are looking at a franchise system with 100 units, don’t be alarmed if there are 2-3 actions listed. As mentioned in a previous post, a franchise is like a marriage. And, if you have 100 marriages, some of them don’t turn out well. (Too bad real marriages had only a 3% dispute factor).
- Item 2 – Experience. This section will have short biographies of the executive and management team. Look for both depth and breath of the experience they have in the particular industry or space you plan on getting into. I am not real fond of franchise companies that started the business and started franchising the business in the same year. Where’s the history or success in that? Where’s the proven system (that’s usually requires a few years of operation)?
Well, I have to jump off now. I hope this has provided a little more insight to what may seem like an over-whelming document at first. Take your time going through it, little by little. Jot down your questions and note your comments. When you do review it with the franchisor, you will be ready with your questions. And, finally, before you sign the franchise agreement, be sure to consult an attorney that practices franchise law if you don't understand what you are signing. It will cost you a few bucks, but it could save you lots of money in the long run.
The Franchise Frog