Franchise Law – 23 Items of the Franchise Disclosure Document (Part 1 of 2)
Since 1979, any company wishing to offer and sell franchises in the United States has been required to prepare and present a written disclosure document to prospective franchisees.
The document provides extensive information about the company that offers and sells franchises, and the terms of the franchise being offered. Over time, the rules have changed concerning the name and precise contents of the document. But generally, the overall categories of information to be disclosed have remained the same. Today, it is called a “Franchise Disclosure Document,” or an “FDD.”
Here are the first 12 of the 23 categories of information that a franchisor’s FDD is required to contain.
1. The Franchisor, It’s Predecessors and Affiliates.
This category provides a general introduction to the franchisor and the business. It describes the nature of the business, the market for the services or merchandise to be sold, particular laws the franchisee must comply with, the franchisor’s history, and information about companies affiliated with the franchisor.
2. Business Experience.
The FDD identifies the board of directors, officers and other key management personnel of the franchisor, and describes their current positions and employment histories, going back five years. With this information a potential franchisee can assess the business experience of the franchisor’s management in relation to the business of the franchise.
Litigation and arbitrations brought against the franchisor during the last 10 years, and their outcomes are described here. This category also provides summary information on suits and arbitrations that the franchisor brought against its franchisees. This information can be a useful tool in assessing the quality of relations between the franchisor and franchisees, and the types of problems that have occurred, that resulted in litigation.
But it is only a partial tool. The existence of litigation and claims does not automatically mean franchisor-franchisee relations are generally bad. The cases that were brought could be aberrations. The absence of litigation or arbitration does not mean relations are good. There could be disputes that did not result in litigation.
Bankruptcies of the franchisor or management during the past ten years are covered here. As with litigation, the existence of a bankruptcy or two among management does not, by itself, mean the franchise should be avoided.
Many individual managers, like other people, have been forced into bankruptcy for extraneous reasons having little to do with the franchise, such as a spouse or relative experiencing costly health issues. On the other hand, where key management has had one or more bankruptcies, it may be fair to ask why, and evaluate if they are individuals who have problems managing financial affairs.
5. Initial Franchise Fee
This information category discloses all amounts the franchisee must pay to the franchisor before the franchise starts operating.
6. Other Fees
Other Fees include all amounts the franchisee must pay to the franchisor after the franchise starts operating. This can be a particularly useful disclosure as it assists the potential franchisee in understanding the various fees and charges that will be imposed.
7. Initial Investment
The Initial Investment appears in a table that shows, for each category of expense that a franchisee will incur, a high-low range and an overall high-low range for the total investment to establish and start operating the franchise. This disclosure item can be particularly useful for a franchisee in determining affordability of and budgeting a potential franchise investment.
8. Restrictions On Sources Of Products And Services
Franchise systems often set restrictions on who the franchisee may obtain supplies, inventory and services from. Franchisors do this as a quality control measure, and to assure uniformity among the various outlets in their franchise system.
This category discloses the restrictions that the franchisee will be subject to in obtaining merchandise and services for the franchise.
9. Franchisee’s Obligations
The obligations table outlines 24 categories of obligations the franchisee will be required to comply with, and identifies particular sections in the Franchise Agreement, and/or in other agreements to be entered into, that concern that type of obligation. Rather than state the substantive obligation, this disclosure table points the franchisee to the statement of the obligation in the written agreement to be entered into.
Many franchisors offer to assist their franchisee with financing the franchise investment, either by accepting a promissory note for some of the investment obligation, or by making arrangements with third party lenders. This disclosure item provides a table summarizing key aspects of any financing arrangements that the franchisor is willing to make.
11. Franchisor’s Obligations
This disclosure category is one of the most extensive in the FDD. It summarizes assistance the franchisor has promised to provide before the franchise starts operation, and ongoing assistance to be provided after the start of operation.
Franchisors usually offer a training program in the operation of the franchised business. This category details the training, in a table that lists subjects, hours devoted to each, and whether that portion of the program is conducted in a classroom or on-the-job setting.
Other subjects addressed in this disclosure item include information on the franchisor’s advertising program, existence of advertising cooperatives, required participation in an advertising fund, details of any electronic point-of sale system the franchisee must purchase and the table of contents of the franchisor’s operating manual.
Franchisees often want, and receive, a promise of exclusivity in a geographic area or market sector. Their franchisor promises not to establish another franchise within a stated area or market sector. This disclosure describes any territory exclusivity for the franchisee, how it is determined, and the circumstances in which exclusive territory may be modified.
In my next blog, we’ll discuss the final items franchisors must divulge in Franchise Law – The FDD Part 2 of 2. In the meantime, please contact me if you have any questions regarding franchise law, the Franchise Disclosure Document, or any of the points above.