The Franchise Disclosure Document, or FDD, is a legal document that the Federal Trade Commission (FTC) requires franchisors to provide to franchise candidates, at least 14 days prior to a sale. A FDD is intended to give candidates the information they need to make a wise decision on whether or not to buy a particular franchise.
The FDD (formerly known as the Uniform Franchise Offering Circular, or UFOC) became mandatory July 1, 2008, as part of the FTC's amendment of its 1978 Franchise Rule. The original Franchise Rule was instituted to protect franchise candidates from disreputable franchisors, especially concerning claims about how much money a franchisee could earn.
While FDD stands for Franchise Disclosure Document, it could equally stand for "Franchisee Due Diligence." Because that's what the FDD is all about: It's part of the due diligence process each candidate must undertake - thoroughly - before signing a franchise agreement.
"The purpose of the disclosure document is to provide candidates with a full picture of the model, both the upside and the downside of it," says Brian Spindel, president of PostNet.
Jim Belanger, president of Gamer Doc, says the FDD's purpose "is to give the person the same knowledge we have so they can make an informed decision. Our FDD is about the industry, where it's going, weaknesses, the competition -- generally all the things they wouldn't find out themselves."
Both franchise veterans strongly emphasize the importance of going beyond the FDD and speaking directly with franchisees to learn more, especially when it comes to financial performance representations (formerly called earnings claims).
According to the FTC, "the amended Rule requires franchisors to give prospective franchisees material information, including background information on the franchisor, the costs of entering into the business, the legal obligations of the franchisor and the franchisee, statistics on franchised and company-owned outlets, and audited financial information. In addition, if franchisors elect to make any financial performance representations, the amended Franchise Rule requires certain disclosures and substantiation for those representations." A sample Table of Contents, listing all the items required in an FDD, is included at the end of this article.
Under the amended Rule, franchisors must provide an FDD to candidates "at least 14 calendar days before the prospective franchisee signs a binding agreement with, or makes any payment to, the franchisor or an affiliate in connection with the proposed franchise sale." The clock starts ticking the day after delivery of the document, which can be delivered in printed or electronic form.
However, under the amended Rule, franchise candidates can request an FDD earlier in the process "upon reasonable request." This is usually interpreted to mean after the franchisor has given a positive response to a candidate's initial application and the sales process is under way. Franchisors cannot charge any fee for earlier delivery.
The FDD is a long, complex legal and financial document that usually runs between 100 and 200 pages. Since it's written by franchise attorneys working to protect the interests of the franchisor, find yourself an attorney to review it - and not just any attorney. Find a reputable franchise attorney; franchise law is a specialized field. Running it by your accountant is also a good idea. Would you buy a car without a mechanic inspecting it, or a home without a house inspector giving it the once-over?
About 30 percent of franchisors provide financial performance representations in Item 19 of the FDD. This information varies greatly, from simply listing gross revenues at each unit (or a selected sample of units), to more detailed data on expenses that can be used to determine net profit, or at least to complete a reasonably accurate pro forma. As noted above, speak with a broad cross-section of franchisees to "reality test" the figures disclosed in the FDD.
As the old saying warns, "We're from the government and here to help." But in the case of the FTC, they really mean it. One final piece of cautionary advice from the FTC, courtesy of your tax dollars at work:
"To protect you, we've required your franchisor to give you this information. We haven't checked it, and don't know if it's correct. It should help you make up your mind. Study it carefully. While it includes some information about your contract, don't rely on it alone to understand your contract. Read all of your contract carefully. Buying a franchise is a complicated investment. Take your time to decide. If possible, show your contract and this information to an advisor, like a lawyer or an accountant. … There may also be laws on franchising in your state. Ask your state agencies about them."
Buying a franchise is a life-changing decision, for better or for worse. Get all the advice you need up front, before you sign on the dotted line. A wise decision requires a good understanding of the FDD, as it spells out your obligations, as well as those of the franchisor.
The FTC does not provide copies of FDDs. However, it lists three companies that sell them, and two online sources that provide a list of all FDDs registered in California, at no cost. Also, many states keep FDDs on file and will provide copies if you visit their offices. While the trend is toward increased availability online, we're not there yet.
The for-profit companies the FTC lists are:
The two non-commercial services listed by the FTC make all FDDs filed in the State of California available online for free:
The FTC provides a detailed listing and explanation of all the parts of an FDD at www.ftc.gov/bcp/franchise/16cfr436.shtm.
The FTC also publishes a Compliance Guide for franchisors, listing in even greater detail all the information they must provide in an FDD. To view this 154-page document, go to: www.ftc.gov/bcp/edu/pubs/business/franchise/bus70.pdf.
Item 1. The Franchisor and any Parents, Predecessors, and Affiliates
Item 2. Business Experience
Item 3. Litigation
Item 4. Bankruptcy
Item 5. Initial Fees
Item 6. Other Fees
Item 7. Estimated Initial Investment
Item 8. Restrictions on Sources of Products and Services
Item 9. Franchisee's Obligations
Item 10. Financing
Item 11. Franchisor's Assistance, Advertising, Computer Systems, and Training
Item 12. Territory
Item 13. Trademarks
Item 14. Patents, Copyrights, and Proprietary Information
Item 15. Obligation to Participate in the Actual Operation of the Franchise Business
Item 16. Restrictions on What the Franchisee May Sell
Item 17. Renewal, Termination, Transfer, and Dispute Resolution
Item 18. Public Figures
Item 19. Financial Performance Representations
Item 20. Outlets and Franchisee Information
Item 21. Financial Statements
Item 22. Contracts
Item 23. Receipts
7.7: The Franchise Application
7.9: Getting Legal Advice
Issue II, 2016