Why Emerging Franchisors Need to Pay Special Attention to Item 20 of their FDD
While potential franchisees are eager to dive into a brand’s Franchise Disclosure Document (FDD) at Item 19, “Financial Performance Representations,” franchisors need to pay close attention to how they craft Item 20, “Outlets and Franchisee Information.” The section will contain the information they’ll want to know next.
For sophisticated franchisees, Item 20 has some of the most important data regarding a franchisor's growth record, especially at the state level. Both emerging and established franchise brands need to carefully consider how to convey information about franchise and corporate-owned units.
Item 20 is made up primarily of five tables that display information about franchised and company-owned units for the previous three years. The Federal Trade Commission, the agency that governs disclosure of the FDD, requires the format of these tables to be straight-forward with honest numbers and easy to read to reflect the state of each franchise system. Here’s a breakdown of what each table covers:
- Table 1: Overview of system-wide locations – This table shows gains and losses of franchised and corporate-owned units, as well as the overall change in the entire system. However, using footnotes, franchisors are allowed to explain the events that impacted changes in the number of locations.
- Table 2: Number of franchised locations transferred to new owners in each state where the brand has a presence – This information relates to the sale of a unit by the franchisee to another person or group of persons that is not the franchisor. A franchise system with a high transfer rate could be a red flag to potential franchisees. However, franchisors can explain the reasons for the transfers in footnotes.
- Table 3: Summary of the status of franchised locations, by state – The information in this table shows how many units opened, state by state, in each of the last three years, along with any terminations and non-renewals of contracts and reacquisitions by the franchisor. An inordinate number of terminations, non-renewals and reacquisitions will likely be a cause for concern for franchisee candidates. But, the number of units opened – too few or too many – can also be a telltale sign of mismanaged growth.
- Table 4: Summary of the status of company-owned locations, by state – The information contained in this table is similar to that in Table 3, except for company-owned units. It may include units reacquired from franchisees, units closed and units sold to franchisees. Typically, emerging franchise brands have more company-owned units than franchised units when starting out. But as you grow, the number of franchised units should surpass the number of company-owned locations. Keeping some company-owned locations can be a source of confidence for potential franchisees – they may see the franchisor as having skin in the game and being able to relate to the challenges franchisees face.
- Table 5: Projected growth by state for the upcoming year – Franchise agreements signed but locations not opened, and franchised and company-owned locations planned for the next fiscal year are found in this table. For potential franchisees, too many unopened locations may raise a red flag concerning support for current franchisees. Projected growth numbers, if too high or too low, may be another sign of mismanaged growth and could scare off franchisee candidates.
Inaccuracies in recording the number of units opened, sold, closed, reacquired, transferred and terminated will also be concerning for franchisee prospects. A mistake or intentionally counting incorrectly will make you appear deceptive. To avoid this, make sure the corresponding figures match where necessary. For example, the system-wide totals in Table 1 should match the totals in Tables 3 and 4.
In addition to the number of outlets and their status in the franchise system, franchisors are required to include the name of each franchisee, and the address and phone number of their franchised unit. Franchisors are also required to provide the names and contact information for franchisees who left the system in the last year or who stopped communicating with them 10 weeks or more before the issuance of the FDD. This information is necessary for franchisee prospects to do their due diligence before signing a franchise agreement.
There are some circumstances where the franchisor is not required to share past-franchisee contact information, such as if both parties sign a confidentiality or non-disparagement agreement. However, franchisors are required to inform prospects of those agreements.
Steps for a Strong Item 20
In order to show healthy growth and share contact information for franchisees who will give you and the concept positive reviews, you must start with the basics right from the beginning. Among others, they include:
- Make sure you’re well-capitalized
- Work out any kinks in the concept at your company-owned locations before franchising
- Develop a plan for steady growth – not too slow and not too fast
- Award franchises to entrepreneurs who are well-capitalized and share your vision
- Ensure every franchise location opens and starts off on the right foot
- Provide the support each franchisee needs
For help conveying the right information in your Item 20 or other parts of your FDD, turn to Winmark Franchise Partners. With 30 years of franchising experience and more than 800 franchise owners representing over 1,200 locations for five brands, Winmark Franchise Partners can help grow your brand through sound strategy and expert franchising advice. Contact us here or at (844) 452-4600.