10 Red Flags in an FDD That Should Make You Think Twice

The Red Flags Most Franchise Buyers Miss

Franchise sales teams won’t tell you about problems. The FDD will — if you know where to look. After analyzing hundreds of FDDs, here are the 10 biggest warning signs we see.

1. Declining Unit Count (Item 20)

If the total number of franchise units is shrinking year over year, that’s the clearest signal something is wrong. Look at the “Systemwide Outlet Summary” table in Item 20. A healthy franchise system should be growing.

What’s normal: 5-15% annual growth for established systems, higher for newer brands. Red flag: Any net decline in units over a 3-year period.

2. High Termination and Non-Renewal Rates (Item 20)

Beyond just counting units, look at why units are leaving the system. Table 3 in Item 20 breaks down closures by category: terminations, non-renewals, and ceased operations.

Red flag: If terminations exceed 5% of the system in any year, dig deeper.

3. No Item 19 Financial Performance Representations

While not every franchise without Item 19 is hiding something, the absence of financial performance data should raise questions. If the franchise system performs well, disclosing data helps sell more franchises — so why wouldn’t they?

What to do: Contact existing franchisees directly (Item 20 provides their contact information) and ask about actual performance.

4. Excessive Litigation (Item 3)

Some lawsuits are normal in business. A pattern of franchisee lawsuits about the same issues is not. Look for:

• Multiple franchisees suing over the same problem
• Earnings claims or misrepresentation lawsuits
• Lawsuits that were settled with confidentiality agreements

5. Unlimited Fee Increases (Item 6)

Check the language around royalty rates, technology fees, and advertising contributions in Item 6. Some franchise agreements allow the franchisor to increase fees without limit or franchisee consent.

Red flag: Language like “franchisor may increase the technology fee at its sole discretion.”

6. No Protected Territory (Item 12)

Some franchise agreements provide zero territorial protection. This means the franchisor can place another unit right next to yours or sell products through alternative channels in your area.

Red flag: Any language that allows “franchisor-operated” or “alternative distribution” in your territory.

7. Mandatory Supplier Restrictions at High Costs (Item 8)

Being required to buy from approved suppliers is standard. Being forced to buy from the franchisor’s own subsidiary at above-market prices is a hidden profit extraction mechanism.

What to do: Compare required supplier pricing against open-market alternatives for key supplies.

8. Weak Financial Statements (Item 21)

The franchisor’s own financial health matters. If the franchisor is losing money, has declining revenue, or has going concern qualifications from auditors — they may not be able to support you.

Red flag: Auditor “going concern” language, negative working capital, or accumulated deficits.

9. Short Franchise Term with No Guaranteed Renewal (Item 17)

Some franchise agreements have 5-year terms with no guaranteed renewal. This means you could invest hundreds of thousands of dollars, build a successful business, and then not be allowed to continue operating it.

Red flag: Terms under 10 years without automatic renewal rights.

10. High Franchisee Turnover (Item 20, Tables 2 & 3)

Look at the transfer rate in Table 2 and the closure numbers in Table 3. If a large percentage of franchisees are selling or closing within the first few years, that tells you something about the unit economics.

Protect Your Investment

These red flags don’t automatically mean “don’t invest” — but they do mean you need to investigate further. Our AI-powered FDD analysis covers all of these areas and more, giving you a detailed buyer’s perspective.

Get a full analysis report for any franchise in our library.