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Mar32020
OWNERSHIP

What is the Franchise Disclosure Document and Why is it Important?

The International Franchise Association’s Franchise Business Economic Outlook for 2020 projects the number of franchised businesses in the U.S. will increase by 1.5 percent to a total of 785,316 establishments. Chances are, if you’re an entrepreneur looking to be a part of this growth, you have a million questions about everything from costs and training to earnings potential.

One of the most important sources of information for those investigating how to buy a franchise is the Franchise Disclosure Document, or FDD. It contains 23 sections that provide a vast amount of information to help prospective franchisees make an informed decision about a franchise opportunity. While the quality and contents of the FDD can vary among franchisors, each is required to contain the following sections or “items” in this order.

1: The Franchisor and Any Parents, Predecessors and Affiliates

  • The company and its history including affiliated and parent companies.

2: Business Experience

  • Biographical information and professional experience of the franchise founder and management team.
  • Operational history of the business.

3: Litigation

  • Relevant criminal and civil litigation in the past ten years involving the franchisor, its affiliates, predecessors and individual management team members.

4: Bankruptcy

  • Details about the franchisor, its affiliates, predecessors or any individual management team members that have previously filed for bankruptcy.

5: Initial Fees

  • All upfront fees associated with opening a franchise business such as the initial franchise fee, multi-unit fees, necessary supplies and materials, opening inventory and any equipment that must be purchased from the franchisor.
  • Any factors that determine the amount of the fees.

6: Other Fees

  • All ongoing fees or payments throughout the term of the franchise agreement like royalties, brand development funds, marketing, technology, training and renewal fees along with others that may be specific to the franchisor.

7: Estimated Initial Investment

  • Low to high range.
  • The initial fees disclosed in Item 5 along with expenses related to building-out and equipping the franchise business and the reserve capital needed for the first three months of operation.

8: Restrictions on Sources of Products and Services

  • Outlines what must be purchased directly from the franchisor or designated suppliers.
  • Any revenue or rebates the franchisor earns from selling these source-restricted items to franchisees.

9: Franchisee’s Obligations

  • Franchisee’s responsibilities under the franchise agreement.
  • Includes a summary of all legal obligations ranging from site selection and opening to default provisions and requirements upon termination of the franchise agreement.

10: Financing

  • Funding options offered by the franchisor for initial fees or other expenses in connection to the franchise business as well as the terms and conditions.

11: Franchisor’s Assistance, Advertising, Computer Systems and Training

  • Services and training the franchisor will provide to franchisees.
  • Advertising requirements, computer and software systems that will need to be purchased and utilized in the operation of the business.

12: Territory

  • Details on territory determination (if offered), whether it can be modified and instances where the franchisor reserves the right to operate within that territory.

13: Trademarks

  • Franchisor’s trademarks, service and trade names.
  • Registration status with the United States Patent and Trademark Office and any notices regarding a trademark conflict or dispute.

14: Patents, Copyrights and Proprietary Information

  • Patents, copyrights and other proprietary information related to the franchise system and how they can be used by the franchisee.

15: Obligation to Participate in the Actual Operation of the Franchise Business

  • Requirements for the franchisee’s level of personal involvement in the day-to-day operation of the business.

16: Restrictions on What the Franchisee May Sell

  • Restrictions on the goods and services that may be sold in the franchise business.

17: Renewal, Termination, Transfer and Dispute Resolution

  • If and when the franchise agreement can be renewed, transferred or terminated.
  • The franchisee’s rights and restrictions for resolving legal disputes with the franchisor.

18: Public Figures

  • Any celebrities or other public figures that have been hired to promote the franchise system, along with the amount of their compensation.

19: Financial Performance Representations

  • Sales, earnings or expenses.
  • Franchisor is not required to provide this information.

20: Outlets and Franchisee Information

  • Locations and contact information of existing franchisees and those that left the system in the past fiscal year.
  • The number of franchises that were opened, closed and transferred as well as terminations over the past three years.
  • A projection of anticipated openings in the next year.

21: Financial Statements

  • Audited financial statements for the past three years including balance sheets, statements of operations, owner’s equity and cash flows.

22: Contracts

  • Complete list with attached samples of each contract the franchisee is required to sign like the franchise agreement, related agreements for development, site selection and release, financing and product supply agreements, personal guarantees, software licensing agreements and any other contracts that may be specific to that franchise business.

23: Receipts

  • Signed confirmation to prove the proper disclosure and delivery of the FDD.

The goal of the FDD is to provide prospective franchisees with vetted and validated information that can be used in the decision-making process. It may make for dry reading, but the devil is in the details, especially when it comes to learning how to buy a franchise. The FDD is a treasure trove of information that warrants careful consideration to avoid potential pitfalls.