Is Your Franchise Closing Locations?  Find Out in Franchise Disclosure Document Item 20

21.09.23 09:11 PM By Stacey Riska

We are back on the Franchise Disclosure Document (FDD) looking at Item 20, and it’s a doozy. It's a prominent item, in that there are a lot of numbers and facts and figures that are covered in here regarding the number of units within a franchise being disclosed. 

In this particular Item, it's not like Item 19 where there's a lot of flexibility in how the numbers and information are presented regarding the operations of their franchises. This one is more regarding the actual number of units in operation and the status of those units. We're going to outline each one of the tables included. There are five tables within this Item, and these tables are going to lay out the different numbering that you're going to see for each of these different five areas that must be covered in Item 20

The first one has to do with the system-wide summary of the net change of both franchised and company-owned outlets in the last three fiscal years. 

Item 20 is going to comprise of five tables and every franchise must follow the same lineage of how these tables are structured. In Item 19, when you're talking about money, it's a little bit more flexible. Item 20 is not flexible, and table one compares franchise units versus company-owned units. This can be really insightful when you're looking at a franchise because you want to know are the franchise units increasing, decreasing, kind of staying stagnant as compared to company-owned locations. When we are talking to candidates and we're presenting options to them, we always make them aware of how many company-owned units there are. Because when there's a company-owned unit, that means they have skin in the game. They're practicing what they preach, they're trying new things to help their franchisees. So if you see one where company units might be decreasing, well maybe you want to ask, well, why is that? Maybe it's because they're focusing more on building their franchisees, but maybe there's something going on and it could be a potential red flag. So, this table it's about comparing how franchise units are doing as compared to company-owned units. 

The second table in item 20 is the total number of outlet transfers within each state of franchise outlets, meaning this doesn't include company outlets, these are just franchised outlets by state essentially, and the changes that have occurred. 

So, what are the important things here that if somebody's looking at Item 20 that they should be looking for?

First, you must understand what a transfer is, because it's not a new unit and it's not a closed unit. A transfer is when an existing location is sold to another incoming franchisee. That's what a transfer is. So you're not going to see necessarily big numbers here, but it's nice that they break it down by state. So, for example, we're in Maryland, and as we're reviewing the FDD for a franchise, we're paying attention to this because if we see that in Maryland there are a lot of transfers, what would you likely think?

Of course, you would think that there may be some dissatisfied franchisees. Number two is maybe that state's just a seasonal state and that type of business is having a rough time because it's seasonal, it's tough to say. As we go back to the first table, one of the reasons the number of franchisor-owned units might go down is they may transfer them to the franchisee. So I was going to get to that. I didn't want to say that until we got to the second one because it ties in with that. So let's go right into the third one. 

 The third one has to do with the disclosure and the changes in the status of the franchise-owned outlets located in a state for each franchise for the last three years.

So this one is a little different than the other two in that it's got a lot more variations to what the franchise status is within the numbers. It's going to show it for the past three years so you can see trends over time. Basically, it's going to say, how many outlets were open at the beginning of that year. And then how many new ones might have opened. Did any terminate or close? Did any decide not to renew? Did any get acquired by the corporate entity (the franchisor)? Did any of them cease operations for any other reason? At the end of that, when all that math is done, how many outlets were there at the end of the year? You're going to see that broken down by state over a three-year period. So you should certainly look in your state and the areas around you to see what kind of trends are happening. There might be some insightful things happening, especially in seasonally related types of franchises. So what you hope to see is it trending up. Is there a kind of plateau? Is it decreasing? And you may actually see areas of opportunity that could mean, gosh, there's nobody in my area. This is a great opportunity to come in and dominate.

The next one is the fourth table, and it's the franchisor must disclose the status of company-owned outlets in each state for the last three fiscal years. 

And this is the same kind of breakdown where it's got multiple statuses, but this is the franchisor-owned units

First, these are only company-owned units, and there could be multiple reasons why they're either adding on new locations or getting rid of those locations. One situation could be where the franchisor is selling them to franchisees to take over those locations. Another situation could be that they could be opening new locations because they want to test out new markets before they bring in new franchisees. They may be closing them, or there may be just no market demand, and so therefore they may decide to close some down. So you're not going to necessarily see big numbers. Most of the franchises that we tend to work with don't have a lot of company-owned units. Some of the bigger ones might have as many as 20, but most of the franchises we work with usually have between one and five. So you're not going to see across the whole United States big trends happening in this table.

Overall just look at the trends, but it may be hard to use these trends for the franchisor units since there may not be a lot of them. If one changes, that could have a big impact on the numbers. I think it's more important to look at the franchisee units that have changed status over the particular three-year period. 

The final of them all is the franchisor must disclose its projections of new outlet openings in each state, as well as the number of franchise agreements that have been signed but not yet resulted in the opening of the franchised outlet. 

This one I would look at pretty closely. It doesn't have the details of the previous two, but it has some importance. It's saying how many franchise agreements were signed, but then also how many were opened and that can be a big difference. So a franchise, especially some of these emerging brands, can be really focused on selling franchises. Let's get in there, let's get the territory sold, buy one, get one free, and they're selling large numbers of franchises. However, they are selling these franchise agreements and it'll take a long time to open … two, three years. 

Actually, this happened in our franchise. The franchise was growing so quickly and they were initially an event-based model. The demand for the product was so high that people were constantly saying where's your store? So, the franchise decided, well, we're going to open up brick-and-mortar stores. Well, the franchise really didn't have experience and opening up stores previously, so it was taking them a long time to open them. They had all these new people coming in buying franchise agreements and it was then two or three years later they were opening their doors. So those are the kinds of anomalies that you want to pay attention to.

What's important about this is as you look at different franchises, these numbers are going to be different based on the type of franchise as well. You're going to see more that have been sold and not opened yet in a franchise that's heavily a brick-and-mortar type franchise just because of the time it takes to get everything done, all the permitting, and so on and so forth. Whereas a home services franchise that is home-based, you might be able to get started in a month after training. So there can be a big difference in these numbers with the different kinds of franchises. As a whole make sure that you take that into account if you're looking at a bunch of different franchises that this is not going to be necessarily an apples-to-apples comparison franchise to franchise.

It's a long item. These graphs and charts are very in-depth and provide a lot of good information for you if you're looking and doing your due diligence on a franchise. Certainly, these charts/tables could be tied in with some really good questions that you could be asking the franchisor during due diligence. Referencing these numbers with the franchisees that you're likely going to be talking to (of any franchise) during the due diligence is going to show you know what you're talking about. Read the Franchise Disclosure Document (FDD) and it's going to give you insights that you would normally not get.

As a whole, this is a very insightful item. It seems odd that they kind of put it at the end, but it is right after the financial representations of Item 19 in which it kind of ties in. There's no money here per se, but you do get a lot of trend information and kind of get insights into what's really happening in the franchise both as a whole franchise versus company-owned, and by state. 

If you need any assistance looking over or understanding the Franchise Disclosure Document (FDD) please feel free to reach out to us.

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 Author Bio

I’m Stacey Riska aka “Small Business Stacey”, your franchise placement specialist. I help aspiring business owners find the PERFECT franchise so they can get to the next level in life and business.
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