A crucial task for someone interested in becoming a franchisee is to carefully examine the franchise disclosure document provided by the franchisor. This document is a legal requirement and contains 23 information items essential for evaluating the franchise business. This document also requires annual updates after the end of each fiscal year, including an updated franchise audit.
In this article, we will discuss how to review the franchise disclosure document and the responsibility of the franchisor to update the document.
23 Items for Review in a Franchise Disclosure Document
The 23 items in the franchise disclosure document (the franchise FDD) provide information about the franchisor’s history, franchise cost, financial statements, and the support and obligations under the franchisor-franchisee relationship. Here are key points to consider during the document review.
History
Understanding the franchisor’s history provides context into the franchise business and any warning signs, such as bad management or reputation. To learn more about the history, franchisees should review items 1 through 4 and items 20 and 21.
- Item 1: Covers the franchisor’s history and any parents, predecessors, and affiliates.
- Item 2: Provides information about the franchisor’s management team.
- Item 3: Shows any litigation history or ongoing lawsuits.
- Item 4: Discloses history of bankruptcy filings.
- Item 20: Provides statistical information about the company-owned outlets (business relationships).
- Item 21: Discloses the audited financial statements for the past three years.
These items focus on the franchise’s history. They will provide a clear understanding of the business structure, potential legal disputes, and the financial standing of the franchise.
Fees
Before investing, franchisees should review the document for the fees, estimated initial investment, and any costs that may arise in the future. Items 5 through 7 will answer those questions.
- Item 5: Covers any fees or payments for the services or goods provided by the franchisor.
- Item 6: Outlines other expenses, including operational costs, royalties, advertising, and transfer fees.
- Item 7: Discloses a table chart with the estimated initial investment.
These items will give the franchisee monetary expectations and the total investment they need to become a franchisee.
Franchisor support and franchisee obligations
When there is a franchisor-franchisee relationship, the franchisor provides a valuable support system and obligations the franchisee must follow. A large portion of the FDD focuses on this relationship, specifically the following items:
- Item 8: Franchisor discloses supplies and sources to operate the franchise business.
- Item 9: Franchisee’s specific obligations.
- Item 11: The system to provide training and operations assistance from the franchisor.
- Item 12: The territory and protections for the franchisees.
- Item 14: Intellectual property of the business.
- Item 15: Franchisee’s expectations for day-to-day operations.
- Item 17: Legal rights and obligations for renewals, terminations, transfers, and disputes.
These items cover the franchisor-franchisee relationship. The franchise’s success relies on the franchisor’s support and the franchisee’s obligations.
Financial performance and statements
There are two items in the franchise disclosure document disclosing the projected financial performance of the franchise (Item 19) and the audited financial statements (Item 21). Note that on item 19, franchisors are not required to make financial performance representations unless disclosed.
How Assurance Dimensions Can Help
Item 21 requires audited financial statements of the last three years completed by a third-party certified public accountant. The audited financial statements are shown in a three-column chart for each fiscal year, which includes the auditor’s consent and opinion letters. Franchisors are responsible for searching for an audit firm, such as Assurance Dimensions, to prepare the audit within 120 days after the closing of the fiscal year.
Contact us to learn more about how we can help with your next franchise accounting audit.
