Welcome to the Supplier Spotlight where we’ll sit down with a series of suppliers to discuss key topics related to franchise ownership. Each interview will address a key component of the due diligence process all prospective franchise owners endure – such as financing, marketing, branding, research, legal advice, etc. Enjoy!

Ritchie Taylor, CFE, a loyal leader within the franchising community who heads Manning Fulton’s franchise practice, sat down with the IFA to talk about a critical component of any prospective franchisee’s due diligence process – the Franchise Disclosure Document (FDD). And after more than 15 years helping franchisors create, update, and maintain FDDs and helping franchisees understand them, there are few voices within franchising better equipped to explain the FDD to franchise prospects. Here’s what he shared with our team!

What’s the most common misperception about Franchise Disclosure Documents? Is there a myth, or two, that needs to be dispelled?

There are several common misperceptions about the franchise disclosure document or FDD. The primary misconceptions result because too many prospective franchisee’s fail to review the FDD with a competent franchise attorney. An attorney who concentrates their practice in franchising will be able to assist a prospective franchisee in evaluating the franchise offering, the potential opportunities and the associated risks. The FDD is the map for the due diligence trip and the franchise attorney is the guide. 

What are some of the key red flags an aspiring owner should look for immediately within an FDD?

Any prospective franchisee should first get to know the Franchisor and its officers. Their business, litigation and bankruptcy histories are contained at the beginning of the FDD for good reason as franchising is about relationships, so you learn this information first. And this information contains the first potential red flags for a prospect reviewing the FDD – if the franchise system has excessive litigation or the franchisor’s management doesn’t have relevant industry experience, these are red flags. I also always turn to Item 20 early to get a feel for the unit health in the system – the second potential red flag that can be found in an FDD. If Item 20 contains excessive turnover due to closure, terminations or transfers, those are red flags meriting discussion with the franchisor’s representatives.The third red flag I’d like to highlight is focused on unit level economics. Refer to the fees listed in Items 5 and 6 along with the Item 7 startup costs to determine your cost structure.Then a prospect needs to look at Item 19 to determine if the disclosed revenue will be sufficient to support the projected costs and return the desired return on investment. If the numbers don’t add up, that’s a serious red flag!

Are there important legal and/or compliance issues that FDD’s DON’T address? If so, share a few questions an aspiring franchisee should ask a franchisor to ensure those issues are addressed/reviewed.

A prospective franchisee is entering into a relationship with the brand, franchisor, and their fellow franchisees. Knowing that, an aspiring franchisee can do additional research to assist them in their due diligence process. For example, take the time to get to know the franchisor’s management and their vision for the brand. Conduct industry research to determine if you believe in the vision. Talk to as many existing franchisee’s as you can to learn about their experience. These conversations will help fill in the gaps the FDD could never fill. 

FDD’s can be overwhelming for prospects, particularly those who are exploring franchises for the first time. Are there specific sections a prospect should review first? Is there some kind of FDD review strategy you’d recommend to help first-time franchise prospects?

Honestly, my recommended approach centers on the three potential red flags I highlighted in the second question above. Start with Items 1-4 that described the franchisor, its officers and its legal history. Then, check out Item 20 to explore the unit health in the system. And finally, review the unit level economics in depth to ensure the numbers add up for franchisees.

However, like anything else, there are no shortcuts. Each disclosure item is important and it’s critical you work with an expert to ensure you understand each one.  Read it yourself, then have your franchise attorney review. Then work with your attorney to get your questions answered and have your attorney help you resolve any concerns you may have with the franchisor. 

What are we missing? What have we not asked about FDDs that you’d like to address as a legal and compliance expert?

Franchising is a wonderful way for expanding a business concept. Many of the most successful franchise brands have early adopter franchisees who have helped them grow the business into a thriving brand. Regardless of whether you’re licensing an emerging or an established brand, the key to success remains the same – franchising works best when each franchisee fully understands what they’re buying in to and what they need to do to succeed.

That’s why the FDD is so important – it helps each franchisee enter the franchise relationship with realistic and transparent expectations. So, as an aspiring owner, take the time to fully vet each franchise you’re exploring by reviewing the FDD at great length. The franchise agreement is the most important agreement you’ll sign in the life of your franchise business – take it seriously!

 

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