Katey Wibbenmeyer
As a potential investor, franchisee, or lender evaluating franchise opportunities, the Franchise Disclosure Document (FDD) is a key resource for understanding the structure and details of a franchise system. It helps assess not only the financial potential of a franchise but also its stability, risks, and overall prospects. Below, I'm going to share insights into some of the important elements of the FDD and their role in decision-making, particularly when it comes to evaluating financial stability and financing decisions.
Key Items to Focus On in the FDD
Several items in the FDD are important to review closely. These include Items 1-7, 10, 12, 19-21, and the List of Franchisees. Here’s a breakdown of what these items represent and why they matter:
Item 19: Financial Performance Representations
The Importance of Item 19 Item 19 provides a snapshot of the financial performance of existing franchise units and helps evaluate the overall success of the franchise system. Understanding revenue growth, profitability, and financial sustainability is important in determining whether the franchise is a good fit. If there’s no data available in Item 19, it doesn’t rule out the franchise system, but it does mean that more due diligence is needed to assess its financial viability.
What Financial Metrics Matter? When reviewing Item 19, our team typically look for:
- Revenue and revenue growth
- EBITDA as a percentage of revenue
- Performance across different units (including high, median, and low performers)
- Seasonality: Fluctuations tied to specific seasons
- Major expenses: Key categories such as labor, food, occupancy costs, etc.
These metrics help assess the financial health of the franchise system and understand how it might affect individual franchisees.
Item 10: Financing
Assessing Financing Options. In Item 10, we review the financing options offered by the franchisor, including whether direct financing or lending relationships are available. For franchisors who offer direct financing, it’s important to understand the terms and conditions. Are these terms available to our bank as well? What other financing options, such as leases or installment contracts, exist? Understanding these factors is key to evaluating the overall financial strategy and assessing potential competition within the system.
Franchisor’s Financial Stability
Why It Matters. The financial health of the franchisor can have a big impact on its franchisees’ success. A franchisor that is financially unstable may struggle to innovate, support franchisees, or provide essential resources for growth. This can ultimately affect franchisees’ profitability and their ability to repay loans. Our team examines financial indicators such as cash flow, profitability, and market positioning to gauge the strength of the franchisor’s business. If the franchisor is facing financial challenges, franchisees may face issues such as outdated technology, inadequate marketing support, or limited supply chain resources, all of which can reduce their chances of success.
Item 12: Territorial Rights
How Territorial Exclusivity Affects Financing. Item 12 outlines territorial rights, which are important for preventing the overlap of sales between franchisees. If a franchisee does not have a protected territory, it may reduce the chances of obtaining financing. Market saturation is also a consideration, but this usually requires more detailed discussions with the franchisor and franchisees to understand the full picture. It’s also necessary to consider the target demographics for the brand and whether the market is saturated or still offers opportunities for growth.
Items 5 & 6: Initial and Ongoing Fees
The Impact of Fees on Financing Decisions. Upfront and ongoing fees are part of the FDD. While these fees are important for the franchisee to understand, they do not typically have a material impact on the bank's evaluation of a brand. We review these fees to understand whether franchisees are purchasing single-unit licenses or multi-unit development agreements and to gauge ongoing revenue to the franchisor. This information helps us evaluate the financial health of the system and understand projections and performance metrics for existing locations. For example, we look at whether the franchisor charges the full marketing fund fee or if there are royalty discounts being applied.
Item 3: Litigation History
The Role of Litigation in Evaluation. Litigation history is an important element of the FDD. Previous lawsuits can point to potential issues within the brand. For example, lawsuits related to customer safety or franchisee relations can suggest problems that might affect the franchise’s stability. If there is a pattern of lawsuits or complaints, it may raise concerns about the brand’s future.
Item 8: Supplier Relationships
Franchisor Control Over Suppliers. In Item 8, we review the franchisor’s relationships with suppliers. A franchisor’s control over its supply chain can impact costs, operational efficiency, and overall profitability for franchisees. If the franchisor controls critical supplies, it can lead to more predictable costs. However, excessive control or unfavorable supplier agreements may raise concerns.
Item 17: Renewal and Termination Terms
The Impact of Renewal and Termination Conditions. While we generally assess franchise loans based on the initial term of the franchise agreement, renewal and termination conditions can become relevant for multi-unit owners or financing for existing franchises. These terms affect long-term success and stability and should be understood when evaluating the franchisee’s ongoing relationship with the franchisor.
Item 11: Training and Support
The Importance of Franchisor Support. A franchisor’s training and support system is important for franchisee success. When evaluating a franchise, we look at whether the franchisor provides support in areas such as marketing, operations, and ongoing education. Strong training and support systems increase the likelihood of success for franchisees, which also impacts their ability to repay loans.
Item 20: Earnings Claims and Franchisee Satisfaction
How Earnings Claims and Satisfaction Impact Financing. Item 20 provides insight into the franchise’s growth, past success, and the overall health of the system. Our team looks closely at geographical expansion, the number of closures, and the franchisor’s growth plans. Franchisee satisfaction also plays a role in the decision-making process. Satisfied franchisees are more likely to remain in the system, expand operations, and achieve long-term success. This stability is beneficial for both the franchise and the bank’s loan portfolio.
Conclusion: A Comprehensive Evaluation
When evaluating a franchise for financing, the FDD is a valuable tool for understanding the financial health, growth potential, and overall risk of a franchise system. By reviewing the key elements of the FDD, lenders can make more informed decisions and ensure that franchisees are set up for success—financially and operationally.
At Osgood Bank, we focus on providing personalized financing options to franchisees and support throughout their journey. By carefully analyzing all aspects of the FDD, we aim to help franchisees thrive and ensure that they have the resources they need to succeed in a competitive marketplace.
Now that you know what we are looking for in a Franchise Disclosure Document, read on to learn what you should Look for In A Lender.
