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Decoding the Franchise Disclosure Document, from A-Z – Item #4

Item #4 is probably the most straightforward item in the entire FDD and none of its contents should really come as a surprise. Bankruptcies are public record so any history of bankruptcy within the franchise should come up during your initial research, if you’re doing your due diligence.

Nonetheless, Item #4 is critical for obvious reasons.

What You’ll Learn About:

• Past or current bankruptcies filed by the franchise;
• Personal bankruptcies filed by any of the executives identified in Item #2; and
• Any involvement in other franchise bankruptcies by any of the executives or directors listed.

Item #4 is essentially a carbon-copy of Item #3, except that it covers bankruptcies instead of litigation.

Why is this important? Because a history that includes a bankruptcy or multiple bankruptcies could be a major red-flag and should definitely be looked into and explained.

If the franchise itself has filed for bankruptcy in the past, take note of when, how they recovered (if they recovered) and what’s happened since. Bankruptcy isn’t always a death sentence for a franchise, but it’s never a good sign. Do some research into why the bankruptcy took place and the circumstances surrounding it, both before and after the filing took place. In other words, be fair enough to look at the big picture, but don’t ignore the obvious fact that bankruptcy is a bad sign.

In addition, if one of the executives has a history of either personal or corporate bankruptcy, the same rules apply. Be sure to look at how closely that person may have been involved in the bankruptcy, if they were directly responsible for it, and what they did afterwards. Did they stay with the company for a while, or bail when the bankruptcy was filed? Was their position prior to the bankruptcy directly related to the finances, or were they further removed from the most crucial fiscal decisions? If more than one of the executives or directors has a history of bankruptcy, beware. This could be a sign of poor leadership across the board.

The bottom line is that #4 represents the financial sustainability of the franchise. Though a past that does not include any bankruptcies doesn’t necessarily mean ample profits, a history of bankruptcies is never a good sign.

Next week, we’ll be moving on to the next section of the FDD, relating to the Fees and Costs. Those are important! #5 is a comprehensive summary of the Initial Fees.