Reference

Franchise Glossary

Key terms every prospective franchise owner should understand before signing an FDD or committing capital.

Ad Fund Fee: Ongoing percentage of gross sales paid to the franchisor's advertising or marketing fund. Typically ranges from 1% to 4% of gross sales and is separate from the royalty fee. Disclosed in FDD Item 6.
Area Development Agreement: A contract granting exclusive rights to open multiple franchise units within a defined territory over a set timeline. The developer usually commits to a schedule of openings and pays a lump-sum development fee upfront.
Charge-Off: When a lender writes off a loan as uncollectable. In SBA 7(a) loan data, a charge-off means the borrower defaulted and the lender recovered what it could through liquidation. FranchiseVerdict uses charge-off counts to calculate SBA default rates for each brand.
Default Rate: The percentage of resolved SBA loans that were charged off rather than paid in full. FranchiseVerdict's formula: charged-off loans divided by (charged-off + paid in full). A higher default rate indicates greater financial risk.
Earnings Claim: Financial performance data disclosed in Item 19 of the FDD. May include gross sales averages, median revenue, cost of goods sold, or net income figures. Not all franchisors provide this information.
FDD (Franchise Disclosure Document): A legal document that franchisors must provide to prospective buyers at least 14 days before signing any agreement or exchanging money. Contains 23 standardized items covering fees, obligations, litigation history, and financial data. Regulated by the FTC. See our full guide on what an FDD is and how to read it.
Franchise Fee: A one-time upfront payment to the franchisor for the right to operate under their brand. Typically ranges from $10,000 to $50,000 but can exceed $100,000 for premium brands. Disclosed in FDD Item 5.
Franchisee: The individual or entity that purchases and operates a franchise unit. Franchisees pay fees to the franchisor in exchange for the right to use the brand, systems, and ongoing support.
Franchisor: The company that owns the brand, business model, and intellectual property, and grants franchise rights to franchisees. Responsible for providing training, support, and the FDD.
FTC Franchise Rule: The Federal Trade Commission regulation (16 CFR Part 436) requiring franchisors to provide a Franchise Disclosure Document to prospective buyers before any sale. Establishes the 23-item format and the 14-day disclosure timeline.
Going Concern: An auditor's note indicating substantial doubt about whether the franchisor can continue operating for the next 12 months. A going concern finding in an FDD is a serious red flag that the franchisor may be financially unstable.
Initial Investment: The total estimated cost to open a franchise, including the franchise fee, build-out, equipment, signage, initial inventory, and working capital. Disclosed as a low-to-high range in FDD Item 7. See our guide on understanding franchise investment costs.
Item 19: The section of the FDD where franchisors may (but are not required to) disclose financial performance data such as average revenue, gross profit, or net income from existing locations. About 65% of franchisors include some form of Item 19 data.
Item 20: The FDD section disclosing franchise system unit counts: openings, closings, transfers, and terminations over the past three years. Also includes a list of all current and former franchisees with contact information.
Royalty Fee: An ongoing percentage of gross sales paid to the franchisor, typically 4% to 8%. Some franchisors charge a flat monthly fee instead. Disclosed in FDD Item 6. This is separate from the ad fund fee.
SBA 7(a) Loan: The U.S. Small Business Administration's primary loan guarantee program, commonly used for franchise financing. The SBA guarantees a portion of the loan, reducing risk for lenders. FranchiseVerdict uses SBA loan outcomes as a proxy for franchise unit financial health.
Territory Protection: A contractual guarantee that the franchisor will not open competing units or grant franchise rights within a defined geographic area around the franchisee's location. Disclosed in FDD Item 12. Not all franchises offer exclusive territories.
Turnover Rate: The percentage of franchise units that changed hands in a given year through terminations, transfers, or cessation of operations. Calculated from Item 20 data. A high turnover rate may indicate franchisee dissatisfaction or financial difficulty.
Verdict Grade: FranchiseVerdict's proprietary A–F rating based on a composite risk score. The grade combines SBA default rates, FDD risk signals, revenue-to-investment ratios, and unit growth trends into a single letter grade. See how grades are assigned on any brand page.
Working Capital: The funds needed to cover day-to-day operating expenses (rent, payroll, supplies) until the franchise becomes self-sustaining. Included as a line item in the FDD Item 7 initial investment table. Underestimating working capital is one of the most common reasons new franchise units fail.