If you are business owner thinking about expanding through franchising, one of your first tasks will be to create a franchise disclosure document (FDD) and register it in states that require franchisors to do so. This document will be shared with your prospective franchisees early in the due diligence process.
FDDs contain information that the Federal Trade Commission and certain state regulators believe will help franchisees make an informed decision about whether or not to proceed with a particular franchise. Lusthaus Law recommends clients exercise great care when creating these important documents.
23 items in an FDD
The franchise disclosure document contains information about the franchisor, the franchise system, and the franchisee’s initial investment. Every FDD must contain the following 23 items:
1. Background Information
Item 1 includes background information about the franchisor as well as its parents, predecessors and affiliates.
2. Company Leadership History
Item 2 must include the previous five years of employment for the directors and principal officers of the franchisor.
3. Previous Lawsuits
Any lawsuits involving the franchisor, its parents, predecessors, affiliates, or leadership team must be included in Item 3.
4. Bankruptcy History
If the franchisor, its parents, predecessors, affiliates, or any person identified in Item 2 has filed for bankruptcy, that information must be disclosed in Item 3.
5. Franchisee’s Fees and Payments
Item 5 describes the initial fees that the franchisee must pay to the franchisor prior to opening the franchise for business. At a minimum, Item 5 will identify the Initial Franchise Fee.
6. Recurring/Occasional Fees
A franchisee will likely be required to pay recurring and other occasional fees to the franchisor while operating the franchise. These fees are listed in Item 6.
7. Estimated Initial Investment
This Item contains a chart outlining the estimated initial investment for a reasonable initial period. These expenses often include rent, inventory, equipment, and other associated costs.
8. Mandated Suppliers
In Item 8, the franchisor explains restrictions on the franchisees’ products and supplies including any required suppliers as well as the amount of revenue that the franchisor can receive from the suppliers.
9. Franchisee’s Principal Obligations
Item 8 includes a chart of the franchisees’ different obligations under the franchise agreement.
10. Franchisor Financing
If the franchisor is going to provide financing to its franchisees, the terms and conditions of any such financing must be included in Item 10.
11. Franchisor Obligations
An outline of the franchisor’s obligations to help support the franchisees before and after operations begin must be included in Item 11.
12. Territory Protections
A franchisee may receive certain territory protections, allowing them to be the sole franchisee within that area. Item 12 will disclose any such protections.
13. Franchisor’s Trademarks
Item 13 will list the franchisor’s trademarks that the franchisee may use in operating its franchise.
14. Franchisor’s Patents and/or Copyrights
Knowing what the franchisor has patented or copyrighted helps the franchisee make more informed decisions and this information is included in Item 14.
15. Day-to-Day Operations
The franchisor can place certain requirements on a franchisee, outlining the extent to which he or she must supervise the day-to-day operations of the franchise. These requirements will be listed in Item 15.
Item 16 will identify any restrictions on what products or services the franchisee may sell from the franchise.
17. Franchisor-Franchisee Common Provisions
The Item 17 chart reveals the common contract provisions between the franchisor and franchisee.
18. Public Figures
Some franchise systems use public figures to help market the franchise. These public figures must be identified in Item 18.
19. Optional: Historical/Projected Financial Performance
The only optional Item in an FDD, Item 19 is where the franchisor can provide information about the actual or potential financial performance of its franchises and/or franchisor-owned outlets.
20. 3-Year Franchise Units
Item 20 contains various charts which show the number of franchised units and company-owned units for the prior three years.
21. Franchisor’s Financial Statements
This paperwork includes the franchisor’s balance sheet, income statement, and cash flow statement.
22. Proposed Sale Agreements
Item 22 includes copies of all agreements that franchisees may be required to sign including the following:
- Franchise Agreement
- Territory Attachment
- Non-Competition Agreement
- Lease Rider
- Personal Guaranty
- Release and state-required Addenda
23. FDD Receipt
A prospective franchisee will sign the Receipt page which will serve as evidence that the FDD was provided to the prospect as required by law.
Franchise disclosure documents, by design, contain a great deal of very detailed information – important to franchisees and franchisors. Franchisors must be meticulous in the preparation of their FDDs, and franchisees must be equally diligent in reviewing those documents.
Lusthaus Law has a long history of guiding franchisees and franchisors through the FDD process. You do not need to work through this process alone. Let’s talk.