Franchise Disclosure demystified: understanding the FDD

As someone interested in working with a Franchise model, you've undoubtedly come across the terms Franchise Disclosure or Franchise Disclosure Document before. Look on any Franchising website and you'll see it as one of their 10-step 'own your own location' processes, or ask any Franchising team member the question 'how much money can I make' and FDD will undoubtedly come up in their long and winding answer. 

All of this begs the question, what actually is Franchise Disclosure? In this article we'll break down the different parts of Disclosure in hopes of demystifying it for you.

First, some definitions

We've posted about Franchise Disclosure and the Franchise Disclosure Document in other blog posts, so we'll reference them here. In our post called 'Franchising defined: The ultimate 'Franchising for Dummies' guide', you can see the following definitions:

• Franchise Disclosure: This is a legal process that establishes how a Franchisor (i.e. the person with the system) provides all information deemed essential to making an assessment of the potential risks and benefits of a Franchising opportunity to a Prospective FrancFhisee (i.e. the person interested in purchasing the system). This process varies slightly from country-to-country and region-to-region, however in all cases Disclosure is typically carried out through the sharing of a Franchise Disclosure Document.
• Franchise Disclosure Document (a.k.a. the FDD): This is a document prepared by a Franchisor, in accordance with all relevant Franchise laws, in 'plain English' (i.e. not legal jargon) that provides the Prospective Franchisee with specific information about the business, the business offering, all terms and conditions of the relationship, and the rights and obligations of both sides. It is essentially the de-facto contract between both parties, and typically covers the topics below:
  • A summary of the Franchisor's business and services
  • Initial and other ongoing fees
  • Estimated initial investment and any other required investment throughout the agreement's term
  • Rules around litigation, bankruptcy, conflict resolution, etc.
  • Systems, supports, and services offered by the Franchisor
  • Obligations of the Franchisee
  • Trademarks, patents, copyrights, other proprietary information
  • Financial Performance Representations, Financial Statements, Public Figures 
  • And more
  While originally FDDs were put in place to protect the Franchisee, many Franchisors have come to appreciate the use of these documents. An FDD provides a benchmark or standard for which all Franchise models can be clearly and easily compared. Strong Franchise Models should be excited to share their FDD with you, in accordance with pertinent law of course, as it let's them 'put their money where their mouth is', so to speak. 

These definitions offer a great summary of specifically what Franchise Disclosure means, and how it is done through the use of a Franchise Disclosure Document. In this article, however, we want to expand on the FDD in a bit more detail. Now that you know what it is, what's the best way to navigate reading and processing the information that it contains?

A few tips for reading the Franchise Disclosure Document (FDD)

Tip 1: Seek advice from franchise lawyers and other consultants (like accountants) to help you understand the contents of the document.

We can't stress this tip enough, that's why we've already mentioned it twice in this article! A good accountant can help you decode and breakdown financial statements if you're not good at reading them, and can give you another resource to ask direct questions to that you may not be able to figure out the answers of yourself. This is the optimal time and place to ask your accountant the question of, "What does it look like I'm going to be able to make in this Franchise?". While they'll still tell you that no one can promise you future earnings, and this is just an estimate, you and they will know how actual financial and other earnings statements to use in figuring out the answer to this question. 

Similarly, a good lawyer can help you understand what your rights and responsibilities are and what those of the Franchisor are as well. Which leads us to our second tip...

Tip 2: See Tip #1 - Do NOT cheap out on soliciting third parties to help you review these documents

Just in-case the first two times didn't make it crystal clear, we recommend one more time...no we implore you to recruit a good Franchising lawyer to review these documents with you. Yes, it will cost you money, but remember you are signing up to commit your earnings and the majority of your time for at least the next 5 years (or whatever the term outlined) to this business. While the price tag of a good lawyer might be high now, a thousand dollars today is absolutely worth it if it brings clarity to an agreement that will have the potential to make you or lose you hundreds of thousands of dollars over the next few years. Now that we've exhausted this point, let's move on to Tip 3.

Tip 3: Not all lawyers are made equal when it comes to Franchising! 

If you're trying to read the documents yourself, see Tip 2. If you've got accounting or business experience already, see Tip 2. If you're already a practicing lawyer, see Tip 2! Unless you've worked explicitly in Franchise law before, you need to get a Franchise lawyer to read over this document with you. There a couple reasons why this should be an absolute necessity for you:

1. Franchise Law is unique in how it structures contracts
2. Franchise lawyers can explain to you why the FDD is written the way it is
3. A Franchisor will never change their FDD for you

When you read a Franchise Agreement for the first time one thing is going to become extremely apparent to you: it seems heavily one-sided in favor of the Franchisor. While one-sided agreements are extremely inappropriate and in many cases un-enforceable in most parts of the law, it is precisely how Franchise Agreements are structured, and for good reason.

If we've lost you in what seems to be a completely contradictory message, let's think about why these documents are structured the way they are. This is the mechanism through which a Franchisor ensures that the rules of engagement are clear for anyone looking to join their system. It is through the Franchise Agreement that McDonald's makes sure a Big Mac Meal tastes and looks exactly the same in San Francisco as does in Tokyo. It's through this Franchise Agreement that Arby's is allowed to pay to have their Superbowl commercial air to tens of millions of people all over the country. It's through this Franchise Agreement that Tim Hortons can make sure that the same logo appears on every one of it's buildings. 

It's also through this agreement that McDonald's can quickly close down an operator who has decided not to include fries in their Big Mac Meal, or how Tim Hortons makes sure that one of their operators doesn't decide that they don't need to keep their store clean. It's through this agreement that Arbies can allow every operator to benefit from a Superbowl ad without individually having to shell out millions of dollars for it. In sum, it's through this agreement that the Franchisor can protect it's brand from non-compliance in any form, and thus protect its Franchisees and ensure their long-term success. The Franchise Agreement is one-sided simply because it has to be to make sure that the brand ca continue to operate successfully for the long-term and keep being a winning model for all of the Franchisees who have invested their lives into it over the years. 

A good Franchise Lawyer understands why these documents are structured the way they are, and can give you relevant advice on what you're signing and how it applies to you. In many cases, what looks like a scary clause actually serves to make your life easier as the Franchisee. It's important to have someone in your camp who can clarify these things for you. Alternately, a poor lawyer or one who has never worked with Franchise law before will likely misguide you and misrepresent you to the Franchisor. Which brings us to the third point above, a Franchisor will never change their Franchise Agreement for you, and ultimately our fourth tip...

Tip 4: Be VERY afraid of Franchisor's who have loose or non-existent Franchise Agreements  

Luckily, in today's marketplace it's impossible to find an established Franchise model that doesn't have a properly created Franchise Disclosure Document. However, it's not impossible to find emerging brands that are missing these. Many times, they will try to play it off like a good thing. They'll claim that by not having a Franchise Disclosure Document they save you money in legal fees and time in getting started, they'll swear that their model is so good or so simple that it doesn't need a formal agreement, they'll promise that they do business 'old school' and a handshake is all they need. There is another word for these kinds of businesses: scams.

If you come across a Franchise Model that checks all the boxes you're looking for, but doesn't present Disclosure as a part of the process, and doesn't recommend that you have a lawyer review the documents they send over, you should run away fast. Could they really be 'old school' business owners who graduated from the 'school of hard knocks' who do deals by handshake under the light of the full moon? Sure they could, but I bet you don't want to risk your life-savings to find out.

Similarly, you should be wary of Franchisors who offer to make changes to their Franchise Agreements if you ask. Unless there's a typo somewhere in their document, you should only ever get one of the following two answers from a Franchisor when asking if they can change a part of their Franchise Agreement:

1. "No"
2. "We recommend you switch to a lawyer who has worked with Franchise law"

Remember, Franchisor's have put tens of thousands of dollars, if not more, into creating Franchise Agreements and Disclosure Documents that are not only in full accordance with the law, but ensure that they have all of the protections they need in place to maintain the integrity of their system which likely already  provides a livelihood for hundreds or thousands of people, which may soon include you as well. A Franchisor should always be appreciative of signing a new Franchisee up into the system, but if they're willing to throw away decades of work and thousands or millions of dollars in changing clauses just to sign you up, you should think long and hard about why that might be the case. And if they haven't spent that much money or that much time on their agreements, you should ask yourself how confident you are about their business model to begin with.

Tip 5: Don't be afraid to ask the Franchisor questions about the FDD

Wait...what? You just told me that under no circumstances will they change it, I should get a good lawyer to help me read it, an accountant to explain the numbers to me, that these people have put millions of dollars into developing them, and now you want me to question them on it??  Yes, ask your Franchisor lots of questions about the FDD. Include your lawyers, because they can likely answer a lot of them for you directly, and include your accountant for the same reason, but not Franchisor should be inaccessible to you throughout the Disclosure process. Just because they won't change the contents of the documents, doesn't mean they won't share insights into why it's written the way it is. In fact, a good Franchisor should want to talk with you about these agreements. Chances are if you've gotten to the formal disclosure and application process with them then they want you to be a part of their team, which means that they want you to understand the contents of these documents and feel as good about joining the system as they feel about bringing you in.

Summary

A Franchise Disclosure Document is a vital piece of the Franchise sales process, where a Franchisor can present all pertinent information to you that is needed to make an informed investment decision. This document is built meticulously to be in full accordance with the law and best-practices aimed at transparency and clarity, and should be considerately and carefully reviewed by yourself with the help of a qualified Franchise lawyer and accountant. You should use it to understand fully the obligations and relationship in the particular Franchise model, and your Franchisor should be involved as needed in the disclosure process to bring you clarity and comfort. Remember, that ultimately the FDD is a tool you can use to gain final confidence and clarity before being financially obligated to the Franchisor.