What is the Franchise Development Disclosure (FDD)?
Prior to purchasing any franchise, a potential franchise owner must be given a copy of the franchisor’s Franchise Development Disclosure (FDD) at least 14 days prior to the completion of the franchise purchase. But what exactly is the FDD and why is it required?
In short, buying a franchise is a complex investment, and the FDD provides buyers with the necessary information to make a well-informed buying decision. According to Jim Stapleton, the Vice President of Franchise Development for Caring Transitions, “every franchise has to disclose all facets of franchise ownership, positive and negative within their FDD.”
Created by the Federal Trade Commission in 1978, and made a requirement for franchisors in 2008, the FDD exists for two primary reasons:
- To protect potential buyers as a candidate
- To protect the franchisor against allegations of misleading claims
The FDD includes 23 items, including the franchisor’s franchise agreement and various exhibits that include a list of current and past franchise owners and audited financials of the franchisor. To ensure accuracy, franchisors are required to update their FDD annually or when there is a material change.
Broken into two different pieces, the first half of the FDD describes in straightforward language what is in the actual franchise agreement, which makes up the second piece of the FDD and is written in more difficult-to-understand legal jargon. It is important to note that franchisors are not able to change the terms of the FDD or the information provided in it, as the FTC requires that franchisors play by the same rules. Franchisors can, however, provide an explanation or clarification of the information if there is a question.
The FDD includes the history of the franchisor, which can help to provide a more complete understanding of the company’s future growth and success. This includes the location of the franchisor and how long the company has been in business, as well as information about the leadership team. The FDD is so comprehensive that it includes background information - including anything negative like bankruptcy or legal trouble - for each member of the leadership team.
Of course, the FDD also lays out the initial costs involved in starting and operating a franchise, including the franchise fee and initial overhead costs necessary to get the business operational. In the case of Caring Transitions, the FDD also outlines the Winner’s Circle program, which provides a way for franchise owners to recoup their initial franchise fee by hitting specific milestones during the first five years of franchise ownership.
Also included in the costs associated with franchise ownership are the royalties, which are usually collected by the franchisor on a monthly basis and are based on a percentage of revenue. Royalty fee rates vary among franchisors, typically from 4% to 12% of revenue, depending on the type of franchise business. At Caring Transitions, royalty fees are 5% of revenue. Both parties benefit from the franchise fees and royalties if the franchisor offers a good business system, and the franchise owner follows it.
Another note about the expenses listed in the FDD is the requirement that any fee that could ever possibly be incurred by a franchisee at any time during franchise ownership must be showcased. Of course, a franchise owner may never come across a number of those fees. Some of the fees act as a safeguard to protect franchise owners from one poor-performing franchise to ensure that the actions of one do not negatively impact the entire brand. When read from the perspective that the language included is to protect everyone’s business, the FDD language makes more sense.
Of particular importance in the FDD is item 19, which some FDDs include and some do not. This particular item can be an important indicator of the franchise system’s overall fiscal health and can demonstrate the franchisor’s confidence in its system. For instance, at Caring Transitions the sales team is not permitted to tell a potential franchise owner that they will make a certain amount of money, but the FDD Item 19 does disclose what the average Caring Transition owner makes.
While the FDD provides all of the necessary information to make an informed decision about purchasing a franchise, it is up to the potential franchise owner to read it, understand it, and ask questions, when necessary. And while the FDD is incredibly helpful in providing a wealth of information about the franchise opportunity, the success of a franchise owner typically depends on the work ethic and commitment of the individual franchise owner.
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