The Franchise Disclosure Document. Why it’s important. Why it’s not.
A Franchise Disclosure Document (FDD) is a critical document for you in franchise evaluation. But it can only get you so far in seeing the whole picture of a concept.
A Franchise Disclosure Document (FDD) is a required piece of documentation every franchisor must assemble to comply with, among other regulations, the Federal Trade Commission’s (FTC) Federal Franchise Rule, enacted in 1979.
FDDs contain 23 Items covering all kinds of baseline information key to helping prospective franchisees understand the system into which they are buying. The franchisor must provide the FDD to prospective franchisees at least 14 days prior to signing an agreement, although the FTC does not require filing of this document at the federal level. There are stiff penalties for franchisors who misrepresent information on their FDDs, but for the most part the FTC leaves it up to the franchisor and franchising industry to self-regulate.
Because the document is not required to be filed at the federal level, some states (13 at this time) have additional laws requiring registration of the FDD with respective state agencies, if the franchise will be operating in that state. These “registration states” are:
- New York
- North Dakota
- Rhode Island
There are also states that require “filing” of the FDD, but not full-on “registration.” This distinction is getting us into the legal nitty-gritty, but those states are:
- North Carolina
- South Carolina
- South Dakota
The 23 Items of the Franchise Disclosure Document
The 23 Items, or Sections, in FDDs are intended to compile and standardize key information about the franchisor, to give potential franchisees a snapshot picture of what they need to know about the franchise. Here is a full list of the Items:
ITEM 1: The Franchisor and any Parents, Predecessors, and Affiliates
ITEM 2: Business Experience
ITEM 3: Litigation
ITEM 4: Bankruptcy
ITEM 5: Initial Franchise Fee
ITEM 6: Other Fees
ITEM 7: Estimated Initial Investment
ITEM 8: Restrictions on Sources of Products and Services
ITEM 9: Franchisees’ 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
In addition, FDDs also contains Exhibits, which can include documents referenced in the Items, examples of agreements the franchisee will need to sign, franchisor financial statements, and other information or resources. Exhibits can vary by FDD.
Here are some of the main categories of Exhibits:
- List of Outlets
- List of Former Franchisees
- Franchise Organizations,
- Sponsored or Endorsed
- Independent Franchisee
- Financial Statements
- Franchise Agreement
- Master Development Agreement
- Computer Software Agreement
- Merchant Processing Agreement
- Lease Documents
- Automated Clearing House
- Authorization Franchise Application
- State Addenda
- State Agencies and Agents for
- Service of Process SBA Franchisor
Some registration states will offer FDDs and other documents free of charge through state-sponsored websites. The most notable of these states are California, Minnesota, and Wisconsin. Links to these websites are in the Appendix of this guide. But again, only franchisors who have registered with those states will be listed. There are many other services allowing you to download entire FDDs, or just certain items, for a fee—sometimes a substantial one.
Why Is the FDD Important to You?
The FDD tells you a lot of important background information about a franchise you normally will not be able to find on their website or in sales materials. Since franchisors must provide this information in the same format, it is easy to compare features and issues from franchise to franchise. Information like costs, franchisee obligations, financial performance, lists of franchisees, unit growth rates, backgrounds of key personnel, agreements, and other things are very important for you to review, especially with qualified professionals.
Why Is the FDD Not Important to You?
While the information in FDDs is deemed to be accurate, it has not been reviewed for accuracy by any government regulatory body, even in states requiring filing or registration at the state level. It is the franchisor’s responsibility to ensure the information is accurate. They can get into a lot of trouble if information is found to be inaccurate after the fact, whether by accident or otherwise, which can result in legal action.
More importantly for the purposes of our Franchising: Decoded & Demystified guide, FDDs cannot help you with many of the components of the Franchise Evaluator – listing and providing guidance on the external and internal factors that WILL have a material effect on your business and give you a clearer sense of being in business in your market as well as being in business with your franchisor. Be sure to evaluate the FDD carefully, consulting qualified advisers like accountants and attorneys, but also be sure to understand how far it can get you and where it will fall short.
The Franchise Evaluator will fill in those critical gaps.
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