How To Read A Franchise Disclosure Document

It's very important because one of the other items in the FDD is called a financial performance representation. And this item is optional. If it does not [have a financial performance representation] it cannot provide any financial performance information verbally or outside of the FDD. So franchisors that don't include it can't discuss actual or projected sales or revenues of how their franchisees are doing.

What are some reasons a franchisor would leave that out?

Feirman:There are several reasons. One reason is that the franchisor might not have what it considers to be reliable information about how its franchisees are doing in terms of revenue or earnings. In most systems, but not all, the payments to the franchisor -- the royalty -- is based on the revenue of the franchisee. But some franchisors receive payment in other ways.

Another reason could be that the franchisor does not have a good story to tell. The results of the franchisees are variable and they may feel that it's more advantageous to selling the franchises by not providing this information.

Frankly, a majority of franchisors do not provide a financial performance representation. Some franchisors feel that it sets them up as a target legally when they provide this information. That makes it even more important for the prospective to contact existing franchisees.

What would be considered a red flag in the FDD?

Feirman: A big red flag would be the disproportionate number of legal disputes, litigations and arbitrations in relation to the size of the franchise system. Another red flag is a disproportionate number of terminations, cancellations or transfers of existing franchises.

Sounds like a franchisee needs a lawyer to read through all the nuances.

Feirman: A typical franchisee will not understand what they are reading in a franchise disclosure document. While it is drafted in plain English, usually a lawyer is recommended to review the FDD as well as the franchise agreement.

-- Written by Laurie Kulikowski in New York.

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