The FDD – Why You Care – Jeffrey M. Goldstein

Authored Sep 27, 2016, by Attorney Jeffrey M. Goldstein

Pursuant to federal regulations and franchise laws in various states around the country, before selling a

franchise, the franchisor must provide the potential buyer with a Franchise Disclosure Document (or

“FDD”). Each franchisor’s FDD must closely follow a format that includes:

  • A Cover Page
  • A table of contents
  • Specific information broken out into 23 “Items”
  • Exhibits (including a copy of the franchisor’s standard franchise agreement)

While understanding your franchise agreement needs to be a top priority, it is also important to critically

assess the information contained in Items 1 through 23. In a series of three articles, we will summarize

what you can (or should) expect to see when you open up your franchisor’s FDD.

Item 1: The Franchisor and Any Parents, Predecessors and Affiliates

What You’ll Find

Along with general business information (like the franchisor’s name and address), Item 1 must contain: a

description of the franchise business, the general market for the franchise system’s products or services,

disclosures regarding the franchisor’s franchising history and whether it operates any company-owned

outlets, and information about competition and industry-specific laws.

Why You Care

While Item 1 disclosures tend to be pretty general, prospective franchisees can uncover some key

information in Item 1. For example, if the franchisor has a prior history in franchising (especially an

unsuccessful one) or if the industry has unique legal requirements, this is certainly something you will

want to know going into your franchise opportunity.

Item 2: Business Experience

What You’ll Find

A five-year employment and business experience summary for each of the franchisor’s owners, officers,

directors, and operations or sales managers.

Why You Care

If you are like most people, part of the reason you are considering a franchise is because you want to

benefit from the franchisor’s experience and expertise. Knowing what the franchisor’s officers and key

personnel have (or haven’t) done in the past can be important to making an informed decision about

whether a particular franchise opportunity is a sound investment.

Item 3: Litigation

What You’ll Find

Disclosures regarding whether the franchisor, any of its related companies or any individual identified in

Item 2 is or has been a party to relevant litigation.

Why You Care

Generally speaking, what you want to see in Item 3 is a “negative disclosure” (in other words, the

franchisor does not have any relevant litigation to disclose). If a franchisor has litigation disclosures in

Item 3, you need to find out more.

Item 4: Bankruptcy

What You’ll Find

Bankruptcy disclosures similar to the litigation disclosures in Item 3.

Why You Care

Similar to litigation disclosures in Item 3, affirmative bankruptcy disclosures in Item 4 are rare. It is

critical that your franchisor have financial stability, so you will certainly want to investigate if a

franchisor discloses a bankruptcy in Item 4.

Item 5: Initial Fees

What You’ll Find

Disclosure of the initial franchise fee, any other initial fees (“fees and payments, or commitments to pay,

for services or goods received from the franchisor or any affiliate before the franchisee’s business

opens”) and whether any of the initial fees are refundable.

Why You Care

These are the initial fees you will need to pay to the franchisor. They should be both reasonable and

justifiable in light of the opportunity being offered.

Item 6: Other Fees

What You’ll Find

A table that discloses the monthly royalty, advertising fund fee, renewal fees, transfer fees, and any

other ongoing or future one-time payments imposed by the franchisor for itself or on behalf of a third


Why You Care

Once again, any fees payable to the franchisor should be firmly supported by the value of the franchise

opportunity. Also note that any transfer or renewal fees (i) can significantly impair your ability to either

get out of or renew your franchise, and (ii) may be negotiable.

Item 7: Estimated Initial Investment

What You’ll Find

A table that discloses training expenses, leasing costs, inventory requirements and any other expenses

you are likely to incur before your franchise opens for business.

Why You Care

Like Items 5 and 6, this could probably go without saying. When it comes to investing in a franchise, the

amount of your investment is obviously a top priority. Note that some franchisors provide more-detailed

(and more-accurate) estimates than others, so you may want to speak with some current franchisees in

order to validate your likely initial investment.

Item 8: Restrictions on Sources of Products and Services

What You’ll Find

In Item 8, franchisors are required to disclose any obligations for franchisees to purchase or lease

necessary products or services either (i) from the franchisor, (ii) from a designated or approved supplier,

or (iii) according to mandatory specifications. This includes:

  • Supplies, fixtures and equipment
  • Inventory
  • Computer hardware or software (including POS systems)
  • Real estate
  • Any “comparable items related to establishing or operating the franchised business”

Why You Care

Purchasing controls can often mean higher purchasing prices for franchisees. When a franchisor

negotiates a volume rebate with a supplier, this does not necessarily mean that savings get passed on to

the franchisees. In fact, instead it can simply mean that franchisees lose the ability to shop for

competitive pricing.

Item 9: Franchisee’s Obligations

What You’ll Find

Item 9 is comprised of a cross-reference table that identifies where you can find various pieces of

information (like site selection and pre-opening requirements) in the Franchise Disclosure Document

(FDD) and the franchisor’s standard franchise agreement.

Why You Care

If you are not familiar with reviewing FDDs and franchise agreements (and most prospective franchisees

aren’t), you can use the Item 9 table to get an overview of the key legal and business terms that will

apply if you decide to move forward with the opportunity.

Item 10: Financing

What You’ll Find

If a franchisor (or its affiliate) offers financing of the initial franchise fee, construction costs or any other

amounts to be paid to the franchisor, it must disclose the terms of its financing arrangements in Item 10.

You don’t often see Item 10 financing disclosures (because most franchisors don’t offer financing); but,

when you do, they tend to be fairly comprehensive as required by the Federal Trade

Commission’s Franchise Rule.

Why You Care

If you are considering entering into a financing arrangement with your franchisor, you want to make

sure that you are fully aware of the terms and conditions involved. In addition, you should confirm that

the terms of the franchisor’s financing agreement are consistent with the disclosures in the FDD.

Item 11: Franchisor’s Assistance, Advertising, Computer Systems, and Training

What You’ll Find

Item 11 tends to be one of the longest Items in most franchisors’ FDDs. This is because it covers a lot of

information. Mandatory disclosures in Item 11 include: the franchisor’s pre-opening obligations

(including training), site selection assistance and requirements, and the franchisor’s ongoing obligations

during the term of your franchise agreement.

Why You Care

Just about everything disclosed in Item 11 should also be covered in your franchise agreement. While

you should read Item 11 carefully to make sure you understand and are satisfied with the level of

assistance the franchisor offers, you should be particularly careful to ensure that any material

obligations are also clearly outlined in the franchise agreement.

Item 12: Territory

What You’ll Find

In Item 12, the franchisor must disclose the minimum size, conditions and other key terms related to

your franchise territory (assuming one is provided).

Why You Care

In many industries, an exclusive (or, at least protected) territory can be critical to individual franchisees’

success. Your territorial protections should be sufficient to ensure that you will not face undue

competition from the franchisor or other franchisees.

Item 13: Trademarks

What You’ll Find

Item 13 includes information on whether the franchisor’s principal trademarks are (i) registered, and/or

(ii) subject to litigation.

Why You Care

A recognizable trademark can provide tremendous value to a franchise system. Conversely, lack of

trademark protection can easily lead to undesirable consequences for franchisees. Before you buy a

franchise, you want to make sure that the franchisor is taking appropriate steps to protect its

trademarks throughout the term of your franchise agreement.

Item 14: Patents, Copyrights, and Proprietary Information

What You’ll Find

Item 14 includes registration and litigation information regarding any patents, copyrights or other

proprietary information owned by the franchisor.

Why You Care

Most franchisors do not have any patents to disclose, but some will make general disclosures regarding

protection of copyrights, trade secrets and other confidential information. If your franchisor’s FDD

includes any affirmative disclosures in Item 14, you will want to make sure you have a clear

understanding of how these intellectual property rights will affect your franchise operations.

Item 15: Obligation to Participate in the Actual Operation of the Franchise Business

What You’ll Find

Any restrictions the franchisor imposes regarding who can take responsibility for the day-to-day

operation of the franchised business.

Why You Care

While some franchisors do not require their franchisees to have direct involvement in their outlets’ dayto-day operations, others do. If your franchisor requires direct, “on-premises” supervision, this is

certainly something you will want to know (especially if you are looking for a multi-unit opportunity).

Item 16: Restrictions on What the Franchisee May Sell

What You’ll Find

Any requirements to sell only approved goods or services, as well as any requirements to sell all goods

or services authorized for sale at franchised outlets.

Why You Care

If your franchisor limits your inventory or service offerings, this is something that you will need to take

into consideration when evaluating the financial potential of your franchise. Likewise, if your franchisor

requires you to carry all approved products, is this going to leave you paying for inventory that just ends

up going to waste?

Item 17: Renewal, Termination, Transfer, and Dispute Resolution

What You’ll Find

A table that identifies where you can find key terms in your franchise agreement (such as termination

and renewal rights), as well as summaries of each of these key terms.

Why You Care

If you are struggling to find a particular clause while wading through your franchise agreement, you may

find the Item 17 table helpful. While you can read the franchisor’s summaries of the agreement’s terms

for informational purposes, you should not rely on the summaries as a substitute for obtaining

independent legal advice.

Item 18: Public Figures

What You’ll Find

Information on any sponsorship or endorsement deals the franchisor has signed with public figures

(such as actors, musicians or athletes).

Why You Care

Item 18 disclosures are relatively rare. But, if your franchisor has entered into an endorsement or

sponsorship agreement with a public figure, analyzing Item 18 and asking follow-up questions can help

you get a better idea of the value (if any) that the relationship brings to the franchise system.

Item 19: Financial Performance Representations

What You’ll Find

Either (i) a “negative disclosure,” which states that the franchisor does not provide financial

performance representations; or, (ii) a substantiated disclosure of the actual or potential financial

performance of some or all of the system’s company-owned and/or franchised outlets.

Why You Care

If your franchisor provides a financial performance representation (formerly known as an “earnings

claim”), you will probably want to take it with a grain of salt. Most financial performance

representations come with a host of caveats and disclaimers, and they rarely provide reliable insight into

what any one franchisee can expect to earn. That said, it is certainly worthwhile to review any

affirmative disclosures provided in Item 19 and attempt to validate them with current and former


Item 20: Outlets and Franchisee Information

What You’ll Find

Tables (with accompanying footnotes) that provide three years’ worth of data regarding: (i) franchise

openings and closings, (ii) transfers, (iii) terminations and non-renewals, and (iv) company-owned outlet

openings and closings. There is also a fifth table that discloses the franchisor’s projections for new

openings over the coming year.

Why You Care

Prospective franchisees can glean a lot of useful information from Item 20. Pay particular attention to

any major fluctuations as well as the numbers for “Ceased Operations-Other Reasons” – which often

means that a franchisee went out of business due to lack of profitability.

Item 21: Financial Statements

What You’ll Find

Audited financial statements for the franchisor’s last three fiscal years (except for new franchisors,

which are allowed to follow a “phase-in” approach).

Why You Care

When you buy a franchise, you want to know that the franchisor is financially secure. An experienced

accountant will be able to help you make sense of the franchisor’s audited (or unaudited) financials.

Item 22: Contracts

What You’ll Find

A list of the contracts you will be required to sign if you purchase a franchise.

Why You Care

You will want to make sure you have copies of all relevant agreements so that you can provide them to

your attorney for review.

Item 23: Receipts

What You’ll Find

Two copies of a one-page “receipt” that you will be required to sign when you receive the Franchise

Disclosure Document (FDD).

Why You Care

Federal regulations require all franchisors to obtain a signed FDD receipt from each prospective

franchisee. As noted on the receipt page, you must receive the FDD at least 14 calendar days before

signing the franchise agreement or making any payment to the franchisor in order for the franchisor to

remain in compliance (note that some states have different minimum disclosure periods).

With Thanks

To the Author, Attorney Jeffrey M. Goldstein