Franchise Discovery Day Checklist

Method notes: how the checklist maps to the FDD

The checklist above has 29 questions in six sections. The question wording draws on the practitioner lists cited under Sources (the International Franchise Association, IFPG, and Entrepreneur). The mapping to the FDD below comes from the text of the FTC Franchise Rule,16 CFR 436.5, which sets what each disclosure item must contain. Discovery Day itself is a sales event that the rule does not regulate. The franchisor's written answers are in the FDD, so a good use of the day is to compare what you hear with what the document already says.

• The team and culture. Item 2 names the franchisor's directors, principal officers, and others with management responsibility for franchise sales or operations, with their positions and employers over the past five years. Check the presenters against it.
• Territory and site selection. Item 12 states whether the franchise is for a specific location or one the franchisor approves, any minimum territory, and whether the territory is exclusive. For every territory it also covers whether the franchisor reserves other channels of distribution, such as the Internet, catalog sales, telemarketing, or other direct marketing, and any competing brand the franchisor operates under a different trademark. Delivery-app sales are not named in the rule, so ask about them under the same heading.
• Marketing and the ad fund. Item 11 must say who contributes to an advertising fund, how much, whether franchisor-owned outlets contribute on the same basis, who administers it, whether it is audited, whether its financial statements are available to franchisees, how money was used in the most recent fiscal year (with percentages for production, media placement, and administration), and what percentage goes principally to soliciting new franchise sales.
• Training and support. Item 11 also covers training, the required cash register or computer systems (cost, and the annual cost of maintenance and upgrades), and the typical time between signing and opening.
• Turnover. Item 20 gives three years of outlet counts, transfers, terminations, non-renewals, and closures, plus contact lists. Item 3 covers litigation.
• Required purchases. Item 8 must say whether the franchisor or its affiliates earn revenue from your required purchases, and if so the franchisor's total revenue, its revenue from required purchases, and that revenue as a percentage of total.

Worked example: reading an ad-fund disclosure

This is one checklist item taken apart with a made-up Item 11 entry. The brand, the entry, and the $600,000 sales figure are all hypothetical, chosen for arithmetic only. The sales figure is not a claim about any real shop.

Hypothetical Item 11 entry: franchisees contribute 2 percent of gross sales to the Brand Fund. Company-owned outlets contribute on the same basis. The franchisor administers the fund and it is not audited. Last fiscal year, 62 percent went to media placement, 18 percent to production, 12 percent to administrative expenses, and 8 percent to advertising to sell franchises. The percentages add to 100.

• Contribution on $600,000 of gross sales: 2% x $600,000 = $12,000 a year.
• Media placement: 62% x $12,000 = $7,440. Production: 18% x $12,000 = $2,160. Administration: 12% x $12,000 = $1,440. Franchise-sales advertising: 8% x $12,000 = $960. Check: 7,440 + 2,160 + 1,440 + 960 = 12,000.

Only about three-fifths of each dollar buys media that reaches customers. That is not necessarily a problem, but it tells you what to ask. What does "administrative" include: franchisor payroll, or only the cost of running the fund? Does the 8 percent spent to sell franchises benefit your outlet? The fund is not audited, so ask whether you can see its statements, since the rule requires the FDD to say whether they are available. And ask what local marketing spend sits on top (the checklist's second marketing question), because the 2 percent is not your whole marketing bill.

Reading the turnover numbers with the franchisor in the room

The checklist asks the franchisor to walk through Item 20 in their own words. Here is the arithmetic behind that request. Item 20's status table for franchised outlets has a row for each state and a column for each way an outlet can leave. A hypothetical row: 12 outlets at the start of the year, 3 opened, 1 terminated, 0 not renewed, 2 reacquired by the franchisor, 1 ceased operations for other reasons, so 12 + 3 - 1 - 0 - 2 - 1 = 11 at the end. The two reacquired outlets are the ones to ask about, because the rule defines a reacquisition as the franchisor buying an outlet back for consideration during its term. A buyback does not appear as a termination, so a row can look quiet while units are still leaving.

Two rules on the contact lists matter here. The FDD must list every current franchisee or, as an alternative, all franchised outlets in your state, extended to contiguous states until at least 100 outlets are listed. It must also list every franchisee who left the system in the most recently completed fiscal year, or who has not communicated with the franchisor within 10 weeks of the issuance date. A hand-picked group at Discovery Day is not that list. If the FDD says current and former franchisees sometimes sign provisions restricting what they can say (a statement the rule requires when confidentiality clauses were signed in the last three fiscal years), expect that some former owners will decline to talk. The rule also requires the FDD to name each franchisee organization the franchisor created, sponsored, or endorsed, and each state-incorporated independent organization that asked to be included, so ask to speak with one.

Sourced analysis: what to do with the answers

• Earnings statements. The FTC'sConsumer's Guide to Buying a Franchisesays any claim about sales, income, or profits must be in Item 19, and that no other spoken or written financial performance claim may be made, with two exceptions: the actual records of an existing outlet you are considering buying, and information that adds to Item 19. If a presenter says what franchisees earn, find it in Item 19 and write it down for your attorney, even if the claim sounded casual.
• Deposits and pressure. The Guide says you must receive the FDD at least 14 days before you are asked to sign any contract or pay any money to the franchisor or an affiliate. The rule text,16 CFR 436.2, sets the same 14 calendar days before signing a binding agreement, and the receipt page at the back of the FDD repeats it. A request for a deposit at or right after Discovery Day is a reason to ask when you received your FDD.
• Promises. A 2011 fact sheet from the North American Securities Administrators Association (NASAA), hosted on the Illinois Attorney General's site, warns that a promise a salesperson makes is unenforceable if it is not written into the franchise agreement. Write down every promise you hear at Discovery Day and ask that it go into the agreement or a signed addendum.
• Turnover. NASAA's same fact sheet advises finding out whether a high number of franchisees have closed, transferred, or never opened, and being very skeptical if experienced franchisees are unhappy or cannot be reached. The FTC's Guide says that if Item 20 shows more than a few outlets in your area closing or changing hands, the cause could be weak franchisor support or unprofitable franchises.

Take your notes to your franchise attorney and accountant before you sign anything or pay any money. This page is educational and is not legal or financial advice.