Demystifying the Franchise Disclosure Document
“What is a Franchise Disclosure Document?”
“How to read a Franchise Disclosure Document.”
“What are the important parts of a Franchise Disclosure Document?”
“Why do Franchise Disclosure Documents have to be so darn complicated?”
If you looked at the most common searches including “Franchise Disclosure Document,” you might find some of these questions. The short answer is that a Franchise Disclosure Document (FDD) is a collection of of information the Federal Trade Commission requires franchisors to give prospective franchisees before a franchise agreement is signed. This is primarily for the protection of franchisees, but having fully informed new franchisees is also a benefit to franchisors. Transparency is a great way to start a business relationship.
Below, we will attempt to make a few key parts of the FDD clearer and more understandable. Before we do that, however, keep in mind that the whole FDD is important, not just the parts discussed below. The best way to be sure you fully understand what a franchisor is offering to you and asking from you is to have an attorney review the FDD for a franchise opportunity you’re serious about pursuing. An FDD has 23 sections (items). Here are some of the important sections of the FDD.
The Franchisor And Its History (Items 1-4)
The first four parts of the FDD tell you about the franchisor. You’ll learn about some of the key figures running the organization and their history, the history of the business entity itself and any parent companies, any litigation the franchisor has been a part of, and any bankruptcy issues the franchisor has faced. None of these things on their own are reasons to partner with or avoid a franchisor, but together they can give you a solid picture of who exactly you’re preparing to do business with. Is this a well-established company with experienced leadership? Is this a company that has faced bankruptcy multiple times? These are things you should know and ask the franchisor to explain if you have any questions.
Fees (Items 5-6)
Item 5 covers initial fees and Item 6 details ongoing fees. Potential franchisees don’t have to be told to pay attention to these sections, but knowing the difference is important. Item 5 covers the fees that you may need to pay right at the beginning of your relationship with the franchisor. That word “may” is important. While most of the fees in this section are required, franchisors must list optional fees here as well. For example, if you choose to start your auto glass business with the ability to calibrate safety systems, you will need to pay a fee to purchase calibration equipment. This equipment is listed in Item 5 even though you are not required to pay the fee if you choose to not start your business offering that service.
Item 6 is just as important. It details the fees that you may need to pay as an ongoing part of your relationship with the franchisor. Again, knowing the difference between which fees you “may” pay and which you “must” pay is important. You’ll find royalty fees here (usually “must” pay). You might find minimum advertising requirements here. Not all these fees are things you’re required to pay to the franchisor, but they are all fees the franchisor might require you to pay to someone. The key to take out of Item 6 is knowing (1) which fees you will definitely have to pay and which you might have to pay (and why), and (2) which fees you pay to the franchisor and which you pay to someone else.
Estimated Initial Investment (Item 7)
This is where it can be very easy to get confused about the numbers. What’s the difference between Initial Fees and Estimated Initial Investment? The simplest explanation is this: Initial Fees are only those fees paid to the franchisor, Estimated Initial Investment is the Initial Fees plus everything else it will cost to start your franchise business. An example would be helpful. When you purchase an auto glass franchise from NOVUS, all of the required initial fees add up to $40,000. The Estimated Initial Investment includes this $40,000, but also includes other things you will need to launch your business, but don’t purchase from NOVUS—like a mobile service vehicle, for instance. This is why NOVUS’ Estimated Initial Investment for a mobile franchise is $54,500 – $143,600. NOVUS estimates you will need to spend at least $14,500 more than the fees paid to NOVUS to launch your franchise.
This is the point where you say, “How is a $90,000 range an estimate?!” The Item 7 is a great tool for you to use to plan your initial expenses, but the estimates attempt to be inclusive of all possibilities. For instance, you may spend $0 on a mobile service vehicle, if you happen to already have one, or you might spend $50,000 on a brand new, top-of-the-line, luxury brand vehicle. You likely won’t do either, but you could. Instead, use the Item 7 as a budgeting tool. Ask the franchisor to be very clear about what goes into each category that the franchisor itself does not provide and then shop for exact prices on those things. This way you can establish a much more accurate number for your initial investment.
Financial Performance Representations (Item 19)
Yes, this is the third section in a row about money. Money is not the only important part of establishing a relationship with a franchisor, but it should be a key part of your decision-making process, and the financial performance representations are near the top of the list. This is the section where a franchisor has the opportunity to tell you how much money you will make. In fact, this is the ONLY place a franchisor can tell you how much money you’ll make. If a franchisor is telling you how much money you’ll make, and that information is not found in Item 19 of their FDD, you have a serious problem. Familiarize yourself with this section. If the franchisor starts making earnings claims that aren’t in this section, ask them why those claims aren’t in their Item 19. Often, it is because the franchisor is telling you what one or a few franchisees have experienced as opposed to an average of the whole network. Franchisors must have data from a significant portion of their franchisees to include a figure in their Item 19.
Contracts (Item 22)
The contracts are likely the most important part of an FDD. In fact, most of the other sections of the FDD are simply well-organized summaries of the requirements of the contracts you will sign with the franchisor. Additionally, the contracts are what you will actually be agreeing to be legally bound by. Don’t skim these agreements. Take the time to make notes and ask questions. Obtain professional (legal) assistance in understanding them. There is the least to say here because it is impossible to summarize a franchise agreement in a paragraph, but they are the key to establishing what can be a very rewarding partnership between franchisor and franchisee.
Disclaimer
The above is not intended as legal advice or a replacement for legal advice. Consult an attorney before entering into any legal relationship with a franchisor.
About NOVUS Glass
For over 47 years, NOVUS has remained the industry’s research & development leader in auto glass service. NOVUS has been awarded more U.S. Patents for windshield repair than any other company in the windshield repair industry. For more information on starting a NOVUS business please call 1-800-944-6811 or go to www.novusfranchising.com
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