The franchise disclosure document, also called FDD, is one of the most important documents in a franchise transaction. Prospective franchisees receive this document before making a purchase, and it is very crucial. While it contains some legal jargon that may be difficult to understand, this document can also give you an idea of what to expect as a franchise owner.
Reading the FDD can seem intimidating. The document has a lot of sections, but we have listed below five key areas you need to pay attention to when determining whether or not a franchise is a solid investment for you.
1. Business Experience
This section will let you know how much experience the franchise company has with that kind of business. No matter how attractive a franchise opportunity may be, it is crucial to consider the business’s experience in its industry. Investing in a relatively new franchise comes with a higher risk. However, the fact that a franchise has no-to-little experience does not mean you should call off the deal. The deal could be worth considering if you are ready to put in more hard work.
2. Litigation
Franchises are sometimes involved in litigation or have some disputes with competitors/customers. Check the litigation section to see how many lawsuits the franchise has faced in the past. If the company has a substantial amount of cases against it (which is the case for about 5% of the total franchises), you may need to carry out further investigation.
3. Fees
A franchise may charge a significantly higher fee than its competitors in the industry. At times, a higher-than-usual fee may indicate that the franchise is successful and the price tag is well worth it. However, this could also signal that it’s a bad deal. Further investigation will allow you to know if this is the case for the franchise you’re interested in.
4. Territory
As a prospective franchisee, you want to be sure that you won’t have someone launching the same franchise in your area and undermining your efforts. A lot of franchisors create territory guidelines to protect franchise owners. These guidelines help avoid disputes among franchisees and ensure that the business has a wide coverage. Check the territory you are going to gain when you buy a franchise to know if it’s located in the right areas that will enable you to make a profit.
5. Financial Performance
To determine the financial performance of a franchise, you will need to look at three parts of the financial disclosure document. The first one is in item 19. If the document does not contain a financial performance report (FPR), you will want to request more information from your franchisor. The absence of an FPR could be a warning signal about the business and calls for careful consideration. Another part you will want to look at is Item 4 to find out if the franchise has ever applied for insolvency, and if yes, why they did so. Understanding this is crucial to ensure your business’s success in the long term. Lastly, you will want to check Item 21 to review the financial statements of the franchise brand. These statements will let you know where the company makes most of its revenue. If the majority of the company’s revenue comes from fees, this could be a red flag.
How to Know the Right Choice for You?
While trying to figure out the best franchise for you to own, make sure to spend enough time reviewing the financial disclosure document (FDD). This is because the more you know what to check for, the more protected you’re going to be when it’s time to purchase a franchise.
