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One of the most critical documents in any franchise transaction is the franchise disclosure document (FDD). This is a legal document that’s given to prospective franchisees prior to buying, and it’s an important one. Although there is some legal jargon in it, there are also some important insights about what you can expect as a franchisee.
At first glance, the FDD can feel overwhelming. There’s a lot in there. Here are five of the most important sections for you to focus on when deciding whether or not the franchise is a good investment.
1. Business Experience
This section will tell you about how much experience the company has operating that type of business. Although interesting, it’s important to also look closely at the business’s industry experience. If the franchise is relatively new to the market overall, it could signal more risk. Lack of experience isn’t a deal breaker but it does mean that the deal is worth exploring with more rigor.
2. Litigation
It’s not uncommon for many franchises to have gone through litigation or have some disputes on record. When you look at the litigation section, look at the number of cases that franchise has against it. If there’s a healthy amount, roughly 5% of the total number of franchises, you might want to investigate further.
3. Fees
Sometimes, a franchise’s fee is significantly higher than its industry counterparts. In some cases, this higher fee might signal that the franchise is successful and worth the higher price tag. In other cases, it could be a red flag that it’s a bad deal. Giving the franchise extra scrutiny will help know which is true for the one you’re considering.
4. Territory
When you buy the franchise, you want to ensure that you won’t have someone in your area set up shop and cannibalize your efforts. To protect franchisees, many franchisors set up territory guidelines. These are meant to stop disputes and maintain a healthy coverage of the business. Look closely at the territory you’d get with purchase and see if it’s in the right areas to help you drive a profit.
5. Financial Performance
There are three parts of the FDD to examine when determining financial performance. The first is in Item 19. If there’s not a financial performance report (FPR), you will want to ask for more information. A lack of an FPR could be a red flag and deserves extra consideration. You’ll also want to look at Item 4 to determine if the franchise ever filed for bankruptcy and if so, why. Knowing this is important to your future success. Finally, in Item 21, you should examine the financial statements of the franchise. These statements will where most of its revenues are earned. If they’re coming from franchise fees, there’s a problem.
What’s Right for You?
As you determine what’s right for you in your path to franchise ownership, be sure to spend a healthy amount of time examining and analyzing the FDD. The more you know what to look for, the more protected you’ll be when it comes time to buy.
Susan Guillory is the President of Egg Marketing & Communications, a marketing firm specializing in content writing and social media management. She’s written three business books, including How to Get More Customers With Press Releases, and frequently blogs about small business and marketing on sites including Forbes, AllBusiness, The Marketing Eggspert Blog, and Tweak Your Biz. Follow her on Twitter @eggmarketing.