FDD Item 20: Understanding Outlets and Franchise Information in the Franchise Disclosure Document
Item 20 in the FDD provides a franchise system’s statistical data and the success rate of other franchise owners. And if you’re looking to purchase a franchise, the more you know what to look for in the Franchise Disclosure Document (FDD), the better equipped you’ll be to make an informed investment.
From fully grasping financial statements to understanding the franchise system, you’ll feel more confident signing a franchise agreement after reviewing all the details.
This article will cover what you can learn from Item 20 of the FDD as part of your due diligence.
What Is Item 20 of the FDD?
Item 20 of the FDD covers the franchisor's historical and current information regarding franchise outlets (locations) and franchisee data. This information is outlined in five tables and three sections that follow a specific format outlined by the Federal Trade Commission (FTC).
These tables include details like the number of company-owned and franchised outlets and information about transfers, closures, and terminations. For example, if a franchise closes down mid-year, the FTC Rule determines what must be disclosed about that location in the last fiscal year.
The purpose of Item 20 is to provide you, the prospective franchisee, insights into the track record and turnover of the franchise system. For this reason, don’t be afraid to ask questions and dig deeper if anything is unclear or looks questionable. This is your investment, after all.
Let’s look closer at the FTC requirements of Item 20 in the Franchise Disclosure Document, including each of the five tables.
Table No. 1: Systemwide Outlet Summary
The first table in Item 20 summarizes historical data from the last three fiscal years of all company-owned and franchised outlets. This is so prospective franchisees can get a sense of the size of the franchise system and identify any net changes in that period.
According to the FTC Rule, Table No. 1 must contain five specific columns. These include:
- The type of outlet—company-owned or franchised
- Each year of operation from the last three fiscal years
- The number of outlets at the beginning of the year
- The number of outlets at the end of the year
- Net change with an explanation
Table No. 2: Transfers of Outlets from Franchisees to New Owners
Table No. 2 quantifies information regarding transfers of franchised outlets. It includes the number of franchise transfers over the last three fiscal years and explains why a franchise outlet may have changed ownership.
The purpose is to help potential franchisees understand the dynamics of ownership changes. For example, a former franchisee may have retired or relocated the franchised business.
Lastly, Table No. 2 outlines any fees or conditions involved in the transfer process. This provides transparency to prospective franchisees about any potential financial implications.
The information is in a table format that displays data on the number of transfers, reasons behind the transfers, and any fees or conditions associated with the ownership changes. If additional context is needed, it can be included as an addendum.
Table No. 3: Status of Franchised Outlets
Table No. 3 shows any changes in the status of franchised outlets in the last three fiscal years. They are organized in nine columns by state and include the following information:
- The year of operation
- Number of operating franchised outlets at the start of each year
- Number of closed outlets with reasons behind the closures
- Terminated outlets and details about why they were terminated
- Number of non-renewals from each of the last three fiscal years
- Acquired outlets by way of buy-back, debt, or overdue franchise fee forgiveness
- Ceased operations or ‘other reasons’ with details on closed franchises for reasons other than any of the stated reasons above
- Outlets at the end of the year listed by state
Table No. 4: Status of Company-Owned Outlets
Table No. 4 outlines the status of company-owned outlets over the last three fiscal years.
It aims to provide transparency regarding changes in the franchisor's directly operated outlets. It allows franchisees to compare the growth of company-owned outlets with the overall growth of the franchise system.
Table No. 4 is organized by state and formatted with the following columns:
- Year or reporting period from the last three fiscal years
- Number of operating company-owned outlets at the start of each year
- Total count of company-owned outlets opened during the year
- Number of outlets that were transferred to new owners or acquired by the franchisor during the reporting period
- Total number of company-owned outlets that closed or ceased operations during the reporting period.
- Number of company-owned franchises that were sold to new franchisees
- Total number of company-owned outlets in each state at the end of the fiscal year
Table No. 5: Projected Openings
Franchisors outline their plans for expansion in this critical section of Item 20. Here, you will find projected new franchised outlets by state in the next fiscal year, as well as all currently signed franchise offerings.
When analyzing Table No. 5, you should focus on these three key elements:
- Expected number of new outlets: This figure sheds light on the franchisor's ambitions and growth potential. A higher number may indicate a more robust expansion plan.
- Locations of projected openings: Understanding new planned outlets can provide valuable insights into the franchisor's targeted markets and regional strategies.
- Projected timeline for openings: The timeline for new openings gives prospective franchisees an understanding of the pace at which the franchisor intends to grow.
Contact Information for Franchisees
Franchisors are required to include a list of current and past franchisee contact information in Item 20 of the disclosure document. As a prospective franchisee, reaching out to as many of the franchises on the list as possible will serve you well. Asking a range of current and ex-franchise owners with business experience can help you understand the franchise system better, and you can build a few franchise relationships along the way.
This section should include the following information:
Names and locations of current franchisees: Identifying current franchisees allows you to gather information about their experiences and assess the performance of their outlets.
Names and telephone numbers of previous owners: Access to previous owners can help you investigate ownership turnover and understand the reasons for their departure.
Company-acquired franchises: Information about franchises acquired by the company can be revealing. For example, seeing how well a franchise performed under a franchisee vs. the franchisor can raise some flags.
Confidentiality Clauses
Unfortunately, your due diligence efforts could be thwarted if current and previous franchisees signed confidentiality agreements during the last three fiscal years.
Although not required, franchisors can disclose the number and percentage of current and former franchisees who signed confidentiality clauses within the last three years. And under the Federal Trade Rule, they can explain the circumstances associated with the clause.
If you aren’t able to contact a current or former franchisee, franchisors are required to disclose whether their current or former franchisees signed a confidentiality clause along with the following disclaimer:
“In some instances, current and former franchisees sign provisions restricting their ability to speak openly about their experience with [Name of Franchise System]. You may wish to speak with current and former franchisees, but be aware that not all such franchisees can communicate with you.”
Franchise Associations
The presence of a franchisor’s trademark-specific associations in Item 20 of the FDD is a good sign. It shows that the franchise you’re considering is committed to upholding industry standards, ethical business practices, and the well-being of its franchisees.
Although any associations might be impressive, you must follow up to ensure they are still affiliated, as most associations observe a fiscal year cycle. Ensure that the franchisor’s association hasn’t lapsed and they’re forthcoming with current associations.
What Should a Prospective Franchisee Look for in Item 20?
Understanding the franchisor's historical and current information regarding any franchise opportunity is critical to help you make an informed decision. As you dig into the specifics of each table, pay attention to the trends, transfer rates, closure reasons, and projected openings. Analyzing these tables can offer valuable insights into the franchise system's stability, growth potential, and overall track record.
Most importantly, don't overlook the significance of contacting current and previous franchisees. Their experiences can provide invaluable perspectives, helping you gauge the day-to-day realities of operating within the franchise system.
You may even want to take it further and hire a franchise consultant or franchise attorney to help you understand the nuances and protect your initial investment. Visit BizBuySell’s Broker Directory to find a professional with franchise experience to help you navigate the process of investing in a franchise.