Understanding Franchise Disclosure Documents: Key Elements Explained

Launching a small business franchise is an exciting step in any business owner’s journey. But there are numerous legal hurdles that must be cleared on the way. One of the key steps is to complete an FDD or Franchise Disclosure Document.

But what is a franchise disclosure document? And how can potential franchisees ensure they’ve filled it out properly? Read our handy guide to find out before pursuing your franchise opportunity.

What is a Franchise Disclosure Document?

This legal document is required by the Federal Trade Commission (FTC). It ensures franchisors have provided transparent information on behalf of the franchisor to prospective franchisees before completing a purchase. And it ensures franchisees are making an informed decision before signing.

Like any legal document, there are countless sections outlined in a standard FDD to ensure franchisees are informed. Here are some of the key elements of an FDD so you can better understand what your franchisor has put in front of you.

State Cover Page

Not all states in the United States require that an FDD be completed prior to franchising. However, there are many that do. The states that carry these franchise disclosure document requirements are:

• California
• Hawaii
• Illinois
• Indiana
• Maryland
• Michigan
• Minnesota
• New York
• North Dakota
• Rhode Island
• South Dakota
• Virginia
• Washington
• Wisconsin

In each of these cases, the very first page of the FDD, known as the State Cover Page, will include locally relevant info. This includes any state legislature, context, or other state-specific info that is relevant to the FDD.

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

This section is largely to identify all parties involved in the transaction. It is also intended to help the franchisee understand relationships, business models, and more that may be relevant to the prospective business relationship.

Item 3: Litigation

This section will help the franchisee understand if there are any existing or past lawsuits against the franchisor. Understandably, these may be of consideration as they enter a business deal and must be disclosed.

Items 5 and 6: Fees

These two sections outline both an understanding of initial fees and other fees that are inherent in the business deal. Of all sections, this is likely the most important for the franchisor to understand and agree to. Without that understanding, continuing the franchising process risks a non-informed party.

Item 7: Initial Investment

The franchise disclosure document is designed to ensure all parties understand the terms of the business engagement. Section seven specifically covers the costs associated with franchising that can befall a franchisee. This section may be presented as a specific dollar amount, or as a range, with an estimation of the high and low ends of the range presented.

The investment cost discussed in this section should be a complete inclusion of all dues, fees, and other costs inherent in the franchise setup process. Section 7 should also clearly detail who you’re paying and when it’s due.

Item 9: Franchisee’s Obligations

This section, much like the fees section, outlines a critical component of the business deal. Namely: the legal requirements the franchisee must undertake to properly execute upon the contract.

Item 19: Financial Performance Representations

As transparency is the key to the FDD, item 19 is all about giving the franchisee a transparent picture of the franchisor’s financial history with regard to other franchise locations. More specifically: item 19 offers insight into other franchise locations financial performance, including:

• Gross sales
• Calculated earnings before interest, taxes, depreciation, and amortization (commonly referred to as an EBITDA)

And other metrics of financial outcomes. Pay special attention to data sampling of the franchise location reporting. This will help you benchmark your expectations accurately.

This item will help a prospective franchisee decide whether other locations’ past financial performance matches their expectations and needs before entering into a contractual relationship. Additionally, there’s information that a franchisor may intentionally exclude from their FDD, such as profit. This is an example of an important trust signal, because the more information your franchisor is willing to disclose, the more information you have to make an informed decision.

Franchising Made Easy

There are countless other sections in standard Franchise Disclosure Documents. In many cases, it is likely helpful to view full franchise disclosure document examples for context. To see for yourself, a sample FDD can be found at the Educated Franchisee FDD Exchange.

At Woof Gang Bakery, we like to make franchising simpler for prospective business owners. We run a nationwide franchise system of successful dog grooming franchises and love partnering with intrepid SBOs like you. Learn more about our stress-free franchise process!