Item 20 in the FDD Deserves Your Full Attention.

Published on July 07, 2014

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Individuals considering a franchise opportunity need to review and analyze the Franchise Disclosure Document, commonly referred to as the FDD. Every franchisor is required to have an FDD and provide a copy to qualified franchise candidates.  The FDD consists of 23 items or questions and although the responses to each item may differ, the 23 items are the same whether it’s McDonald’s or a new franchisor.

Administered by the Federal Trade Commission, the FDD provides information pertaining to a specific franchise for prospective franchisees. The items range from Item 1, which provides information about the franchisor, its parents and other information, to “Item 22 Contracts”, that provides exhibits of the franchise agreement and other documents a franchisee would need to execute in the event they purchase the franchise.

Of the 23 items the one that provides a wealth of information but doesn’t receive the attention it deserves is “Item 20 List of Franchised Outlets”. Item 20 lists the number of franchised outlets and company-owned outlets for the previous three-year period including five tables that provide:

  1. The number of franchised and company-owned outlets at the beginning and at the end of each of the last three fiscal years
  2. Transfers of outlets from Franchisees to New Owners, other than the Franchisor.
  3. Turnover rates on a State by State basis for franchised outlets for each of the last three fiscal years. This includes terminations, non-renewals, and franchisor acquisitions of franchisees or franchisees that ceased operations for various reasons.
  4. Turnover rates on a State by State basis for company-owned outlets for each of the last three fiscal years, including outlets reacquired by the franchisor from the franchisee and outlets sold to franchisees.
  5. Projected new outlet openings in the next fiscal year by State and the number of franchise agreements signed in the previous year where a franchise has not yet been opened.

Item 20 must also provide contact Information for up to 100 current franchisees (although some franchisors may include all franchisees) and those who left the system within the last year. The information is limited to the last known address and telephone number of the franchisee. Item 20 will also disclose information about franchisee associations in the franchise and any contractual limitations on franchisees. If a franchisee association exists, there should be contact information as well. An association can provide information regarding the franchise and the investment. Item 20 will also include whether the franchisor has entered into settlement agreements or contracts that limit the franchisees’ ability to discuss their experience with the franchise. These agreements can be a sign that the franchisor wants to keep unflattering information about the franchise system confidential.

A major benefit of Item 20 is identifying how many franchisees leave the system over a 3 year period. The Franchisee Turnover Rate or FTR can indicate how stable a franchise system is. It’s based upon a combination of terminated, non-renewed, franchisees that ceased operations and franchisee acquisitions by the franchisee. A recent report by FranchiseGrade revealed that 50% of franchisors had an FTR of less than 5% for a 3 year period. If you’re considering a franchise that has an FTR of 7% or higher it could be a red flag and you should ask the franchisor and franchisees you speak with why franchisees are leaving the system.

There are other valuable nuggets you can glean from Item 20 that include:

  • Trends over the past 3 years in the number of franchisees, and franchise terminations.
  • A large number of franchises sold but not opened can indicate that the franchisor is more interested in selling new franchises rather than developing existing franchise operations.
  • The number of franchises reacquired by the franchisor can indicate possible problems whereby the franchisor has avoided litigation by buying the franchisee out. In some cases the franchisee may receive a small amount of money rather than sue.
  • “Churning” activity which indicates that a franchisor is terminating or acquiring franchisee locations in order to re-franchise.
  • An increase or trend in company outlets could indicate that the franchisor is de-emphasizing franchising or that franchisees are vacating the system

Item 20 is a treasure trove of information that can indicate a number of trends taking place with the franchise. Many experienced franchise attorneys believe that Item 20 can reveal more useful information than the other items in the FDD. If you’re considering a franchise opportunity be sure to give Item 20 the attention it deserves.

 

Written by FranchiseGrade.com Team


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