The Due Diligence Deep Dive: How to Evaluate a Franchise

In our first post, we established that a franchise is a powerful blueprint for business ownership—a chance to leverage a proven system and established brand. But not all blueprints are created equal, and not every brand is the right fit for you.

Before you invest your time, money, and future into any system, you must conduct rigorous due diligence. This is the non-negotiable process of research and analysis designed to verify the franchisor’s claims, understand the business model, and assess your probability of success.

The cornerstone of this process is the Franchise Disclosure Document (FDD).

What is the Franchise Disclosure Document (FDD)?

The FDD is a comprehensive legal document mandated by the Federal Trade Commission (FTC) in the United States. A franchisor must provide this document to you at least 14 calendar days before you are allowed to sign a binding agreement or pay any fees.

The FDD is not a marketing brochure; it is a legal disclosure, typically consisting of 23 "Items" that cover every major aspect of the franchise relationship.

Key Items to Scrutinize in the FDD

While every item is important, your due diligence should focus heavily on these critical sections:

Item 3 - Litigation History: Lists all legal actions involving the franchisor and its executives. Look for a pattern of disputes, especially those alleging fraud, breach of contract, or high rates of franchisee vs. franchisor suits.

Item 7 - Estimated Initial Investment: Provides a low-to-high range for the total startup costs, including the franchise fee, equipment, working capital, and leasehold improvements. Use the high end of the range and budget extra to avoid being undercapitalized.

Item 19 - Financial Performance Representations: This is optional for the franchisor, but if included, it details historical sales, revenues, or profit figures. If provided, analyze the assumptions and the unit base (company-owned vs. franchised units). If it's blank, you rely completely on your validation calls (see our next post).

Item 20 - Outlets and Franchisee Information: Shows the growth, transfers, closures, and terminations over the past three years, broken down by state. This provides the most critical data: a complete list of current and former franchisees—your contact list for validation.

Item 21 - Financial Statements: The franchisor’s own audited financial statements. A strong franchisor should earn most of its revenue from royalties (Item 6), not solely from the sale of new franchises (Item 5).

Item 12 - Territory: Defines whether you receive a protected territory and how the boundaries are determined. Ensure your territory is clearly defined and that the franchisor cannot place a competing unit too close to yours.