Once you have decided to expand your business through franchising, one of the next steps is to create the Franchise Disclosure Document (FDD). The FDD contains information about the franchisor and the franchise system. The Federal Trade Commission and state regulators require franchisors to provide this information to potential franchisees to help them make an informed decision about whether to buy the franchise. However, the task of creating the FDD is also a benefit to the franchisor as it requires the franchisor to make crucial business decisions and gather necessary information right at the start of the franchising process.
The FDD must provide information on 23 items. While some of these may be straight-forward, others entail gathering detailed information that will become part of the FDD. Some of the most common issues which can delay the FDD or get franchisors into trouble include the following:
Who will be involved in operating, managing and selling the franchise? The FDD must include specific information about the franchisor’s owners, directors, members, officers, sales personnel, and certain other personnel. This includes 5 years of employment history. In addition, the franchisor, its directors, officers, sales personnel, predecessor, parent or affiliate may also have to disclose pending or past litigation, arbitrations, judicial proceedings or bankruptcy filings.
Where will the franchise be offered and sold? Some states require filing, registration, special disclosure or registration of the franchisor’s trademark before the offer or sale of franchises.
Will advertising be used in the offer or sale of franchises? If yes, then some states require advertising to be filed prior to its use.
What is the amount of the initial investment a franchisee will have to make in the business? The franchisor must estimate the expenses to be incurred by the franchisee during the pre-opening phase and the “initial period” of operating the franchised business.
What materials will the franchisee be required to obtain from the franchisor? The franchisor must describe the types of goods, services, supplies, fixtures, equipment, inventory, merchandise, computer hardware and software (including a point-of-sale system) and real estate that the franchisee must obtain from or through the franchisor, its affiliates and/or other approved suppliers.
Will the franchisor provide financing arrangements to franchisees? If yes, the franchisor must disclose the identity of any lender and the financing terms.
What assistance will the franchisor give to franchisees? This may include training, site location, construction and installation, management training, ongoing training and other assistance, advertising and loaning a copy of an operations manual.
What intellectual property (trademarks, copyrights, patents) will be licensed to the franchisee? Intellectual property must be specifically identified including information on whether it is registered and limitations on its use.
Does the franchisee have to personally operate the business? The franchisor must decide whether the franchisee must personally supervise the on-site operations of the franchised business. If it is not required, the franchisor must specify the restrictions and requirements for managers.
How much control does the franchisor want over the franchisee in its sale of goods and services? Any restrictions must be specified.
What are the terms for renewal, termination, transfer and dispute resolution? These must be specified as provided under the Federal Trade Commission Franchise Rule.
Will the franchisor make any financial performance representations? This is the only optional item of information. However, if the franchisor is going to provide prospects with information about the actual or potential financial performance of its franchised and/or franchisor-owned outlets, that information must be included in the FDD. Including a financial performance representation may make the franchise more marketable if the franchisor shares positive financial performance figures. If the information is provided, it must meet certain requirements.
What financial statements are needed? Depending on which state the franchisor is in and in which states the franchisor is interested in offering franchised businesses for sale, the franchisor may need to include audited financial statements as part of its disclosure document.
What contracts are relevant to the sale of the franchise? The franchisor will need to prepare and attach contracts, such as the Franchise Agreement, Territory Attachment, Non-Disclosure, Non-Competition Agreement, Lease Rider, Release and state-required Addenda, and an individual guaranty to be signed by all owners of a corporate franchisee.
This is not a complete list of the documentation needed or the decisions that must be made for preparation of the FDD. Franchisors should consult an experienced franchise attorney to review in detail the 23 items of the FDD in order to ensure all relevant information is included.
In our next post, we will discuss additional information in the FDD, including how to decide on the business terms for offering your franchise.