Franchise Disclosure Document Dissected - Part Three

We pick-up our observations about the Franchise Disclosure Document (FDD) with Item 11 - Franchisor's Assistance. If you missed Part One or Part Two, you can click on the hyperlinked text. 

Item 11 is the most comprehensive in the FDD - and an important one for both sides of the franchise equation. Just a few insights here on some of the topics covered in Item 11:

Operations Manual - nearly every franchise system has an operations manual. The manual is the "bible" for the operating system - operational requirements are enforced through the franchise agreement. Item 11 mandates two alternative disclosures regarding the manual: either the Table of Contents must be provided OR the buyer must be given the opportunity to review the manual before purchasing. Few franchisors offer the opportunity for review and only provide the Table of Contents. TOC's are typically generic and offer little insight into the manual. Few franchise-buyers go further and rely on a cursory TOC review. This is an important piece! Franchise-buyers should request access to the manual and serious franchise systems should grant greater access (protected by a non-disclosure) before the sale. Little is gained by looking at the TOC.

Training - another important item is training. Item 11 discloses the Training Program in a Table format, covering the subject, hours in the classroom and on-the-job, and the training location. A generalized description of the program is usually offered and the instructional materials, along with the instructors' experience. Here is the observation: many times franchisors do not fully disclose required information about the instructors. It is not acceptable to simply refer back to Item 2 ("Business Experience" of the main officers). The name of each instructor and their length of experience "in the field" and with the franchise system is required. So franchisors, be proactive and offer the full information; franchise-buyers, make sure you get all the information.

Time Limit to Open - Item 11 discusses the amount of time franchise buyers will have to secure a lease and open the business. Everyone is interested in opening as soon as possible. But, some of the time-frames are too short, too unrealistic. In some markets getting a lease alone can take 6-12 months. This is really a negotiating point for the franchise agreement - seek to expand the deadline. Most franchisors are flexible on this point ... because they realize it may well take more time than they estimate.

Hopefully, one more part upcoming to finish the dissection!

Franchise Disclosure Document Dissected - Part Two

We continue our review of Franchise Disclosure Documents (FDD) from a few insights that have come my way over the years. Insights that may be of value to franchise purchasers and franchise companies alike. If you missed Part One, you can find it here. We will not cover every FDD item but focus on the highlights.

Today let's start with FDD Item 5:

• Initial Fees - this item covers the amount of money or fees paid directly to the franchise company at the beginning of the process. Typically referred to as the "initial franchise fee," this amount should be clearly indicated in Item 5 and match the corresponding amount or amounts disclosed on the Cover Page. On the Cover Page, the franchise company should have at least two amounts disclosed: the total estimated investment required that corresponds to the Item 7 chart (Estimated Initial Investment) and the amounts that must be paid to the franchisor to get started (Initial Fees), again matching the Item 5 amounts. If there is a development agreement fee or other initial charges due to the franchisor, those amounts must be disclosed and accurately reflected on the Cover Page. If the amounts don't match something is wrong.
• Estimated Initial Investment - Item 7 is arguably the most important item in the FDD. It is supposed to inform readers of the total expenditure to get started (so it should repeat the Item 5 amounts plus a variety of other expenses) and identify the working capital needed for at least the first three months. Franchisors are wise to  draft this section carefully and review it on an annual basis to ensure accuracy. Although it is an "estimate," grossly understated amounts could lead to disputes when a franchisee's experience is negative and the start-up estimate was below par. Franchise buyers should not stop at the Item 7 estimate. Asking other franchisees about their actual start-up cost and how it compared to estimate, is highly recommended. As an example, sometimes smaller items such as professional fees (attorneys and accountants) are under-estimated. Franchisees need to conduct due diligence on this important item. Finally, if there is a development program, a separate estimate should be provided for that.
• Financing - If the franchise company offers financing for start-up costs (including inventory and equipment) or assists with securing a loan, it should be explained in Item 10. Here is something I have encountered, especially with new franchise systems: no disclosure or indication of financing is provided in Item 10 but "to make a deal" a franchisor enters into an installment payment arrangement with a franchise purchaser for some of the initial fees or costs. This is financing! And the terms of any financing MUST be explained in Item 10.

More later!