Red Flags in the FDD: What to Watch Out For

So you’ve found a franchise you want to buy into and are eager to jumpstart the process. Then comes navigating all the paperwork. At this point, you’ll be introduced to the Franchise Disclosure Document (FDD). If you’ve never studied law, this is likely the most legalese you’ve ever seen.

Despite the complexity, this document is actually designed to give you a glimpse behind the curtain to better educate you on your purchasing decision. Unfortunately, all that information is muddled in a complicated and overly formal presentation. That makes the red flags a little harder to spot.

To help, I wanted to dive into a few of the potential warnings signs you need to be wary of. Think of it as your roadmap to finding skeletons in the closet.

Litigation

Browsing through Item #3, you’ll discover previous and current litigation. The practical reality is that any franchisor that has been around a long time, as well as a very recognizable brand, will have disputes with franchisees.

You’re looking for an extreme volume of litigation, as well as evaluating for the merits of the action. For example, did several recent operators feel that their business struggled due to lack of promised training? What about a franchisor’s response to a poor performing unit? Did they sue for owed royalties or advertising dues?

Another potential flag would be litigation around initial investment claims. You’ll base a lot of your financial decisions around the initial investment outline, which means you’ll unlikely be prepared if the costs soar far above projection. The integrity of those numbers is important.

Check out the most litigated issues in the FDD.

Territory

Territory plays a big role into your success. You don’t want to invest five years building recognition in a territory to suddenly be cannibalized by units opening on the fringes of your territory. Avoid that by doing intensive market research for your region, as well as comparing the metrics against franchisees in similar markets. Use this knowledge to evaluate their territory allotments, as well as factoring in whether or not you have exclusive territory.

See more on reviewing a franchise’s territory allocations.

Historical Growth

Coming upon Item #20, you’ll dive into the history. Don’t pass this one up just because it reminds you of the dull lessons in high school. There are several things you need to look for. First, evaluate the rate of open, termination, and closings. Evaluate the regional makeup, again taking into consideration your market. A lot of terminations and closings raise eyebrows about the health of the organization.

On the flip side, too many franchises sold in a short period of time and a long opening schedule might mean that they don’t have the bandwidth to properly train and support a new franchisee.

Financial Condition

Item #21 will outline the financial strength of the franchise. This snapshot will help either validate or poke holes into your analysis of market strength and industry trends. Even if you’re looking into a franchise operating in a hot market, poor financial health might indicate problems with the business model.

Your Navigator for the FDD

The FDD represents the most complex, robust, and downright daunting legal document you’ll ever encounter. More importantly, once you sign the franchise agreement, it controls your legal rights and obligations for the remainder of your franchise term.

Don’t take any chances. Partner with an experienced franchise lawyer to review this with you, ensuring you have a strong legal foundation to take the leap in owning a franchise unit. As both a part franchise owner and seasoned franchise lawyer, I work with individuals just like to you review the FDD, point out red flags, and legally protect franchisees.