Breaking Down the FDD
SPECIAL SECTION: PART 1
Breaking Down the FDD
Item 7: Estimated Initial Investment
You’ve heard it before: Be sure you understand your Franchise Disclosure Document (FDD) before you buy into a franchise. The advice makes sense—after all, the document is there to protect you by listing everything the Federal Trade Commission (FTC) believes you need to know about your franchisor. But given that it’s a 150-page legal document, many prospective franchisees aren’t always clear on the details.
It’s complicated, we get it. So, to help you understand the finer points of the FDD, we’ve enlisted Nicole Micklich, a franchise attorney. In the next six issues of Franchise Dictionary Magazine, she will highlight some common misunderstandings about the document and clarify them. Here, we launch with the topic that everyone needs to be clear on: Money.
Under the FTC Franchise Rule, in Item 7 of the Franchise Disclosure Document, the franchisor must provide an estimate of the likely initial investment costs a franchisee will incur. Don’t confuse Item 7 with Item 5. Item 5 only discloses the initial fees that must be paid to the franchisor or affiliate. Item 7 should be more detailed than Item 5.
Item 7 requires franchisors to use a table to set out a franchisee’s entire estimated initial investment. The table is supposed to disclose all the expenses required by the franchise agreement and all other costs necessary for a franchisee to open for business, including those that are to be paid to third parties, like rent.
The Rule does not dictate a complete list of the types of fees or expenses that must be shown in the table. The Rule provides suggestions of the typical expenses franchisees will incur. Franchisors should also identify and itemize other specific required payments franchisees must make to start operating.
Item 7 covers the period that ends when the franchisee opens for business. It also requires franchisors to include in the table “additional funds” for the time during the “initial period” of operations. The “initial period” can vary depending on brand, and franchisors must disclose the specific initial period used in the FDD.
For each item listed in the Item 7 table, the franchisor must disclose:
• The amount of the payment
• The method of payment
• When the payment is due
• To whom the payment is to be made
Some of the costs set out in the Item 7 table may be difficult for the franchisor to estimate and the franchisor may use ranges or variables. Franchisors use footnotes to provide more information about the Item 7 expenditures. If the franchisor offers different types of outlets, like restaurants that offer both stand-alone units and units in convenience stores, the franchisor might use more than one table.
As you consider the purchase of your franchise, you and your advisors should carefully and cautiously use Item 7 and other information provided by the franchisor to prepare a financial model for your start-up costs.
The Cost of Franchising
There are numerous costs associated with starting your franchised business, including:
• The initial franchise fee
• Travel and living, to re-locate or for training, until business becomes profitable
• Organizing and registering a business entity
• Obtaining business licenses and permits
• Negotiating a lease or purchase of real property (franchisor may require a real estate consultant)
• Security deposits, utility deposits
• Rent or mortgage payments
• Insurance, including renter’s, auto, workers’ compensation, commercial general liability, officers and directors
• Remodeling, leasehold improvements, and decorating
• Advertising and marketing, both required and optional, and grand opening
• Payroll, including pre-opening payroll during employee training
• Vehicle(s), truck(s), trailer(s), and/or vehicle wraps or paint
• Computer hardware
• Telephone system
• Computer software, including POS
• Promotional items
• Opening inventory
• Cash on hand
—Nicole Micklich is a franchise attorney with Garcia & Milas. Contact her at 203-773-3824 or firstname.lastname@example.org