When you start making your way down the franchise purchase road, there comes a point where you’ll be asked to sign a non-disclosure agreement before you’re able to get your hands on the franchise disclosure document (FDD). In this document you’ll find unit counts, costs, royalties and financing info.
With a lot of legal-speak and business jargon going on, here are three of the most important sections that you need to understand in the FDD.
Before you buy, know what you’re in for.
Essential #1 Litigation
An FDD should contain information on pending and prior litigation against the franchisor, as well as litigation filed by the franchisor against franchisees. Some litigation is inevitable, especially when dealing with old and large companies.
But if a company’s list of litigation goes on for page after page, take a closer look. Take note of who filed the suits, when they were filed and why. If there are many filed by franchisees, that could be a red flag. Likewise, a large amount of franchisor-initiated litigation could signal deeper problems.
Litigation isn’t a matter of determining how squeaky clean a brand is, but offers some of the greatest insight into whether franchisees are satisfied with the system.
It reveals what the areas of conflict are and how the franchisor typically handles conflicts when they arise. But if you want to know even more (and you should), the best thing you can do is talk to current and former franchisees – who should also be listed in the FDD – to get their take.
Essential #2 Earnings claims
It’s the biggest question on the minds of prospective franchisees: How much money can I make? That’s where earnings claims come in and are important. Here, franchisors can make financial performance representations but be cautious – if it’s too good to be true, it probably isn’t.
Other issues to be aware of are: Not all earnings claims are what they appear. Some franchisors offer a comprehensive look at how all the franchises in their system are faring financially. But others offer only the average sales for their system, sales for a select few units or sales of company-owned units rather than those of franchisees. Also, earnings claims may not necessarily show the whole picture;gross sales are one thing, but profits are another.
In short, when seeking the answer to the big money question, don’t take earnings claims at face value as they’re just the first step in your research, and one to be taken with a grain (or block) of salt.
Essential #3 Rate of turnover
We’re not talking money turnover here, but store turnover. Look for the section in your FDD that has lots of tables and a wealth of information on growth over the last few years.
In particular, you’re going to want to find information which displays how many franchises were opened each year, how many were terminated, not renewed at the end of their term, re-acquired by the franchisor, or ceased operating for other reasons.
These numbers can be just as important to consider as the company’s overall growth. If a company is losing numerous units each year – even if it’s still managing positive net growth – it’s time to ask questions.
Find out why there’s so much turnover and whether franchisees are actually experiencing long-term success with the business model or simply being replaced faster than they leave.