One of the Most Important Items in the Franchise Disclosure Document

Ed Teixeira

Date

Aug 12, 2016

When considering a franchise opportunity, a key component of the franchise evaluation process is reviewing the Franchise Disclosure Document. There are 23 Items in a Franchise Disclosure Document (FDD) and each one is an important part of a larger portrait that depicts a franchise system. However, some Items are more important than others. One of the more important Items is Item 20, which contains tables that present data on franchise growth, franchises sold but not opened, franchisee turnover, the sale of franchises referred to as transfers and the various reasons for franchisee terminations. It also presents projected new franchise additions. All of this data is presented for the most recently completed 3-year period, by State and totaled.

When reviewing Item 20, whether as a prospective franchisee or franchise attorney, each piece of data is important individually and in total. The information presented in Item 20 can provide a clearer indication of whether a franchise system is healthy or unhealthy. One of the more telling statistics is the Franchisee Turnover Rate or FTR. This can indicate whether or not there are potential problems in a franchise system. FTR is defined as a combination of terminated, non-renewed, ceased operations and franchisor franchisee acquisitions posted in Item 20 in the FDD. When dividing this number by the number of franchise locations we can identify a percent for the FTR. As an example, a previous analysis of franchise systems with a minimum of 100 locations by www.franchisegrade.com revealed that:

  • 18% of all franchisors have a 3 year FTR higher than 10%.
  • 38% of franchisors have a 3 year FTR of less than 5%.
  • 12% of franchisors have a 3 year FTR of 1% or less.

Franchise systems with a lower FTR percent can indicate a healthier franchise system. However, as in most cases, there are exceptions to every situation and for that reason the FTR is one important component of an in-depth franchise due diligence process.

The Information in Item 20 is important when analyzing a potential franchise investment, but it may not tell the whole story. Collection, analysis and interpretation of data within the FDD is a critical component of a prospective Franchisee's due diligence requirements and process. A candidate and their advisors can’t look at one part of an FDD and make a determination on the health of a franchise investment opportunity. Rather they need to analyze every Item, compare the data to other franchise systems and look at the aggregate results to help narrow down your options and minimize your investment risks.

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