Franchising is a two-way street. While franchisors evaluate candidates to determine whether or not they’re right for their brand, it’s also up to prospective local owners to figure out if they want to be a part of one concept’s system over the other. And in order to do their due diligence, franchisees need to thoroughly look through a brand’s Franchise Disclosure Document, or FDD.
Between their 23 items and hundreds of pages, FDDs have the potential to seem overwhelming. But for franchisees looking to do a little research into the health of a brand’s system, the best place to look is Item 20. The Federal Trade Commission Franchise Rule (16 C.F.R. Part 436) Compliance Guide describes Item 20 in detail, but it is comprised of many specific sections and details. The International Franchise Association (IFA) does a good job condensing these details to say that Item 20 describes “outlets and franchisee information: [t]his section provides locations and contact information of existing franchises.”
Charles Internicola, founder of The Internicola Law Firm, says “Item 20 is critical to learn about the history of a specific franchise. It tells you everything you need to know about their openings and closings in addition to their franchised and corporate locations. And it’s incredibly helpful for franchisees looking to gain an understanding of a franchise system’s overall health. The only time that Item 20 won’t provide essential information is when you’re looking into an emerging or startup franchisor.”
By looking at a brand’s Item 20, prospective franchisees are able to see how many openings and closings a brand has had over the past five years. And it’s critical for candidates to check for consistency—having a number that’s too high or too low could potentially be a red flag.
“It’s essential for franchisees to know how consistent a brand is when it comes to store openings,” said Pete Lindsey, vice president of franchising for Sport Clips. “Too few store openings can indicate that there’s a lack of interest or a lack of existing franchisees willing to expand. Too many openings, on the other hand, can mean that brands are compromising their standards when it comes to site and franchisee selection.”
Beyond providing details about a brand’s track record when it comes to openings and closings, Item 20 of a brand’s FDD also gives prospective franchisees an idea of how many transfers are taking place within a brand’s system, in addition to how aggressive the franchisor is when it comes to terminating licenses. This allows prospective franchisees to determine how easily they’ll be able to sell their franchise when it’s eventually time for them to move on.
However, according to Cheng Cohen LLC founding partner Amy Cheng, it’s essential for candidates to dig further than the information provided exclusively in Item 20.
“At its core, Item 20 of the FDD gives you a sense of a concept’s growth. It’ll tell you how fast a brand is expanding in addition to how many units have been signed, but aren’t open yet,” said Cheng. “But it’s important for candidates to go beyond researching the information that’s listed in a brand’s Item 20. For example, if an Item 20 indicates rapid growth, you’ll want to make sure that the brand has the infrastructure in place to support that pace in the long-term.”
At the end of the day, Item 20 of a brand’s FDD is a one stop shop for prospective franchisees who are interested in getting an overall sense of a concept’s growth. By examining the past health of a franchise, future owners have a better idea of what that potential looks like going forward.
“We look at our Item 20 as a place where potential franchise owners can get to know us as a brand,” said Dave Wells, Sport Clips’ director of franchising. He continued, saying, “Item 20 is one of the most ignored areas of franchise disclosure documents, but it’s also the most valuable.”