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Franchising 101: Franchise Disclosure Documents Explained

Franchise-Disclosure-Documents

Franchising is a great way to get into business without having to build a brand identity from the ground up. With a franchise business, you get instant brand recognition and can generally expect a quick return of investment (ROI).

However, before signing up for a franchise, you need to do your due diligence by carefully going over your Franchise Disclosure Document. This piece of documentation outlines everything you need to know about the franchise. Among these are your responsibilities as a franchisee, patents, restrictions, financial statements, and normally privileged information—such as any ongoing litigation—among others.

All in all, the FDD contains 23 items. For your peace of mind, you should go over all 23 of them to know everything there is to know about the company that you’re buying into. To get you started, here are answers to the top three common questions that should be answered upon looking through your Franchise Disclosure Document.

1. Who are the people behind the franchise?

Before going all the way, you’ll want to verify the identity of the people behind the brand. After all, you will be using their brand equity for your own business.

This information is located in the first item, usually called The Franchisor and any Parents, Predecessors, and Affiliates. This section gives you the history of the franchise operation, including any parent companies that gave birth to the present franchise. Any affiliated company that plays a major role in the day-to-day operation of the franchise will also be disclosed here as well.

Item 2: Business Experience lists the names of the executives and provides their professional backgrounds. Sometimes they also contain some biographical information as well.

Item 3: Litigation and Item 4: Bankruptcy details whether or not the franchise has ever faced lawsuits or has filed bankruptcy in the past or present. While a high number of lawsuits can be a red flag, it is more important to check the nature of the lawsuits and how they were resolved.

Meanwhile, Item 20: Outlets and Franchisee Information will list crucial information, such as name and contact details, about past and present franchisees of the company in the past three years. As a potential franchise owner, it would be wise to contact these franchise owners to have a better grasp of the business. You should also take note of their locations. As a potential franchise owner, you may want to avoid cannibalizing sales from fellow franchisees who sell the same products as you do.

2. How lucrative is the franchise?

In most cases, financial projections are either left vague or undisclosed. This is part of the franchisor’s efforts of avoiding any potential claims of misinformation. However, if your franchisor does choose to divulge this information, it will be found in Item 19: Financial Performance Representations.

Meanwhile, Item 21: Financial Statements contains audited financial statements covering the past three years of the business. While this is not an exact measure of how much you stand to gain in business, it is nevertheless useful in gaining a better understanding of the business.

3. How much do I need to open this franchise?

Apart from the franchise fee, you will be spending capital for build-out costs, equipment, inventory, and other expenditures before you can open the business to the public. This information is itemized in Item 5: Initial Fees, and Item 7: Estimated Initial Investment.

Meanwhile, ongoing fees such as royalties, marketing, training, brand development, and other fees are in Item 6: Other Fees. If your franchisor opens financing schemes, this information will be in Item 10: Financing.

Conclusion

Entering into any business venture involves understanding and mitigating risk. However, by doing your due diligence in going over your FDD, you will be in a good position to decide whether the risk is manageable or not. When in doubt, it’s best to contact past and present franchisees to get real-life knowledge about the franchise.

Optamark is a brand management company with a mission to take over the world. With our Optamark Franchise opportunity, franchisees can leverage our deep knowledge of the industry to grow their own business. Connect with us and be a part of the Optamark community today!

 

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