Franchisors are generally required to provide prospective franchisees with a franchise disclosure document (FDD) before a franchise agreement is signed or any consideration is paid for the franchise. The FDD includes information about the franchisor, the franchise system, and the franchisee’s initial investment. This information is intended to provide franchisees with the opportunity to make an informed decision about the investment. Every FDD contains 23 Items of information, the first of which is Item 1 – Background Information.
Item 1 offers details on the franchisor as well as its parents, predecessors and affiliates. It is meant to be a simple introduction to the system. Today we will discuss the topics franchisors should include and what franchisees can look for in Item 1.
The FTC Rule and NASAA
In an effort to simplify and streamline the format of all FDDs, franchisors must follow the format required under the Amended Federal Trade Commission Franchise Rule (FTC Rule) and in accordance with requirements established by the North American Securities Administrators Association (NASAA).
An experienced NY Franchise Lawyer will know and recognize this format, but franchisors and franchisees should be familiar as well. Find more guidance from NASAA here.
The FTC Rule requires franchisors to provide prospective franchisees with the FDD at least 14 days before they sign any agreements with the franchisor or any money is paid. As previously discussed, some states have different timing requirements for disclosure of the FDD. For example, New York requires franchisors to provide prospective franchisees with an FDD at the earlier of the first personal meeting or 10 business days before the execution of any agreement or payment of any consideration that relates to the franchise relationship.
Item 1: An Opportunity for Franchisors
Franchisors must include the following categories of information in Item 1:
- The Franchisor. Name, address and other basic background information.
- Parents, Predecessors and Affiliates. Identification and basic background information about the franchisor’s parent company, predecessors and certain affiliates as applicable.
- Franchise Offered. A description of the franchisor’s business and franchise offered, including information about the business that the franchisee will conduct.
- Market for the Product or Services Offered. A description of the general market for the product and services offered by franchisees, including such factors as whether the market is developed or developing, whether sales are seasonal, and whether goods or services will be sold primarily to a certain group.
- Industry Regulations. Any laws or regulations specific to the industry in which the franchise business operates.
In addition, Item 1 is where franchisors can include a bit about their story. Every franchise was launched through an innovative or superior product, experience or service. Taken a step further, the franchise may have been inspired by a family recipe or an entrepreneur who wanted to take a risk. Franchisors can include their rich history and mission in Item 1. However, the FTC Rule does limit the information that franchisors can include in the document, which is why it is important to work with an experienced NY franchise attorney when preparing an FDD.
Fact-Finding for Franchisees
Franchisees can look to Item 1 for information about the franchisor’s corporate structure and experience in the industry. It is where franchisees may be able to confirm verbal discussions previously had with the franchisor about its history. For example, if the franchisor was recently acquired by a competitor or other group such as a private equity firm, this should be documented in Item 1.
However, where, for example, the franchisor has been through several acquisitions, this information may not be clearly described in Item 1 and an experienced NY Franchise lawyer will know how to spot certain gaps in the information and have it clarified by the franchisor.
Contact Lusthaus Law
Franchisors must be meticulous in the preparation of their FDDs, and franchisees must be equally diligent in reviewing those documents. Item 1 of the FDD should set an honest and clear tone for the rest of the document as well as the relationship between franchisor and franchisee.
Lusthaus Law has a long history of guiding franchisors and franchisees through the FDD process. Contact us today to learn more about how Lusthaus Law P.C. can help you navigate a clear path for your franchise’s successful future.