Franchisors have the right to designate what products and services franchisees must use in the operation of their businesses. This ensures that they meet the franchisor’s standards and the suppliers have been properly vetted. While franchisees can be required to use certain suppliers, franchisors must provide information about mandated suppliers in Item 8 of the Franchise Disclosure Document.
In Item 8, franchisors must “[d]isclose the franchisee’s obligations to purchase or lease goods, services, supplies, fixtures, equipment, inventory, computer hardware and software, real estate, or comparable items related to establishing or operating the franchised business either from the franchisor, its designee, or suppliers approved by the franchisor, or under the franchisor’s specifications.”
Where the franchisee does have such an obligation, the franchisor must provide specified details about the products, services, and suppliers. Among the required information is whether the franchisor will or may derive revenue from required purchases or leases by the franchisees. This is important because many franchisees do not realize that purchasing from a particular supplier may be a source of revenue for franchisors. The suppliers may be paying the franchisor a rebate on sales they make to franchisees. This may impact the franchisee in that the cost of these goods and services may be higher than what a franchisee could obtain on the open market. Such costs should be evaluated by the franchisee before entering into the franchise agreement, which is why it is required to be disclosed in the FDD.
If the franchisor is deriving revenue from the supplier’s sales to franchisees, Item 8 must describe how the amount is calculated by stating:
(i) The franchisor’s total revenue.
(ii) The franchisor’s revenues from all required purchases and leases of products and services.
(iii) The percentage of the franchisor’s total revenues that are from required purchases or leases.
(iv) If the franchisor’s affiliates also sell or lease products or services to franchisees, the affiliates’ revenues from those sales or leases.
While designating certain suppliers is a common practice with legitimate business reasons, franchisees must understand how it affects the costs and potential profitability of their franchise. Issues like this are complex. Even where alternative suppliers may be permitted, the requirements that alternative suppliers must meet should be carefully examined to determine the time, effort and costs associated with finding and approving those alternative suppliers. An experienced franchise attorney can go through each item of the FDD to explain how it may impact the business.
If you are considering purchasing a franchise or you are a franchisor unsure about what information must be disclosed, contact us for a consultation.