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Decoding the Franchise Disclosure Document From A to Z – Item #1

Before you officially become a franchisee and sign your franchise agreement, the Federal Trade Commission requires that you receive a Franchise Disclosure Document (FDD) from the franchisor. A mound of legalese, this document contains 23 critical ‘Items,’ all designed to make you a more knowledgeable franchise buyer. So, while daunting, the document is also very revealing and should be critical to your final decision. To make the process more understandable and transparent, we’re devoting 23 separate blog posts, for each of the 23 items.

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

#1 for a reason, this item describes, in detail, the company’s ownership and history, including all of its predecessors, parent and affiliate entities.

You’ll also learn:

  • How long the franchisor has been in business
  • Any changes in ownership
  • Types of franchises being offered
  • Your likely competition
  • And any special laws that pertain to the franchise and/or industry

Overall, it’s a very detailed picture of who the franchise is and where they’ve been.

 

Why is this important? Without this background information, you really don’t know where the franchise is coming from or what they’ve done in the past. And, like any good investment, “Those who don’t know history are doomed to repeat it.” Knowing the franchise’s history gives you a solid understanding of how they came to be where they are, who got them there, and who they’re competing against.

When reading Item #1, be suspicious of a lack of clarity, fuzzy explanations, date gaps, or other red flags, such as explanations from the franchisor that don’t match the FDD. This could be an indication that the franchisor isn’t fully vested in the process, doesn’t quite appreciate the magnitude of what they’re doing, or, even worse, has something troubling to hide. If you get stuck on Item #1 and have too many unanswered questions, it’s likely that you’ll have problems with the rest of the FDD, as well.

The bottom line is that Item #1 exposes the risks. This item should be where the franchisor reveals any skeletons in their closet, black marks from their past or obstacles to your success. This is their first opportunity to explain what they have to offer, while honestly revealing the challenges. The more thorough Item #1 is, the better, because it shows that the franchise isn’t trying to hide anything devastating, and is being honest about the risks of the business. This type of truthfulness and authenticity is a good indication that you’d be getting a sound business partner backing your new franchise.

Stay tuned next week when we break down Item #2: Business Experience and Franchise Executives.