Entering a franchise business can be a great way to start your small business. By being a franchisee, you don’t necessarily need business experience to run a franchise. Franchisors will usually provide the training, resources, and support you need to operate their business model.
As a franchisee, you will however need to pay an initial franchise fee to the franchisor for the rights to use their brand in addition to ongoing franchise fees for marketing, royalties, and more.
Before entering an agreement with a franchisor, you must go through the Franchisor’s Franchise Disclosure Document (FDD). An FDD is a legal disclosure document that is provided to individuals interested in buying a franchise as part of the pre-sale due diligence process.
In simple terms, it gives a clear picture of the business relationship between the franchisee and the franchise. A franchise disclosure document is an essential piece of paperwork when starting a franchise. But what is a franchise disclosure, and what should be included?
What Is a Franchise Disclosure Document?
A Franchise Disclosure Document (FDD) is a document required by the Federal Trade Commission that sets clear guidelines for the franchise relationship. It is a legally-required document that a franchisor provides to prospective franchisees. It discloses important information about the franchisor.
Franchise agreements may vary between different franchises, but often include sections such as the use of trademarks; location of the franchise; general terms of the franchise; franchisee’s fees and other payments; obligations and duties of the franchisor; restriction on goods and services offered; and renewal, termination and transfer of franchise agreement
What Is an FDD in Business?
Franchise Disclosure Document (FDD) helps to provide prospective franchisees with information about the franchisor, the franchise system, and the agreements they will need to sign so that they can make an informed decision. The Federal Franchise Rule requires that the FDD must be disclosed to a potential franchisee no less than 14 days prior to them signing a franchise agreement or paying any money to the franchisor.
Once the prospective franchisee signs the FDD receipt page (item 23 of the document), the 14-day period begins. According to the law, every FDD must include 23 disclosure items.
Why Are Franchise Disclosure Documents Important to a Franchise Business?
The FDD lets prospective franchisees analyze and decide if they want to purchase a franchise. It also provides an opportunity to know more about the franchisor, its legal history, company structure, financial status and agreements, existing franchisees, franchisee’s obligations, initial fees required, and more.
What Should Be Included in an FDD Franchise Disclosure Document?
Under the FTC’s Amended Franchise Rule, a franchisor selling a franchise must include twenty-three (23) items in its FDD. While the contents of each item may vary with each franchisor, each FDD is required to contain the following items in this order:
1. The Franchisor and any Parents, Predecessors, and Affiliates
The franchisor must provide a description of the company and its history. This would include affiliate companies, the business concept to be offered, the market for the product or service offered, known government regulations with which the franchisee must comply, and the competitors a franchisee may face in the business.
2. Business Experience
Here the franchisor must disclose information about the franchisor’s management team, franchise sales, and franchisee support team members.
The franchisor must list specific litigation relevant to the franchise company, whether civil or criminal, pending or settled, whether they are plaintiff or defendant.
The franchisor must disclose whether or not the franchisor, the franchisor’s affiliates, predecessors, and/or individual management team members identified in ‘Item 2’ had previously filed for bankruptcy.
5. Initial Fees
Franchisors must disclose all upfront fees that a franchisee must pay to the franchisor before the franchisee opens the franchised business. It should also include how and when and under what circumstances payment should be paid.
6. Other Fees
The franchisor must disclose all other fees that a franchisee must pay to the franchisor throughout the terms of the franchise agreement. These fees may include ongoing royalties, brand development funds, marketing, technology, training, and other fees specific to the franchisor.
7. Estimated Initial Investment
The franchisor must provide information on the franchisee’s total estimated investment to get started in the franchised business. Here franchisors must include a low to a high estimate of the estimated cost for a franchisee to establish and open the franchised business. This estimate must include everything from build-out costs to reserve capital for the first three months of operation.
8. Restrictions on Sources of Products and Services
The franchisor must disclose what products and supplies the franchisee must purchase from the franchisor or the franchisor’s designated suppliers. The franchisor must also disclose revenue and rebates that the franchisor earned from selling source-restricted supplies and products to franchisees.
9. Franchisee’s Obligations
The franchisors must disclose, the franchisee’s obligations under the franchise agreement. This includes a summary of all legal obligations ranging from site selection and opening to default provisions and the franchisee’s obligations upon termination of the franchise agreement.
The franchisor must disclose whether or not it would offer franchisees financing as to initial fees to be paid by the franchisor or in connection with the franchised business.
More Important Information to Put in a Franchise Agreement
The franchise disclosure document (FDD) previously known as the Uniform Franchise Offering Circular (UFOC) is a legal disclosure document that must be given to individuals interested in buying a U.S. franchise as part of the pre-sale due diligence process. Additional items required by law to be included in the FDD include:
11. Assistance, Advertising, Computer Systems, and Training
The franchisor must disclose the type of assistance and training that it would provide to the franchisee. In addition to the advertising requirements to be imposed on the franchisee, and the required computer and software systems that the franchisee will be required to purchase and utilize.
The franchisors must disclose if the franchisee will be awarded a protected territory, whether or not the territory is protected, how the territory will be determined, and instances where the franchisor reserves the right to operate within the franchisee’s territory.
The franchisor must disclose information about the trademarks of the franchise system, including, whether or not they are registered with the United States Patent and Trademark Office, their registration status, and whether or not the franchisor has notice of a trademark conflict or dispute.
14. Patents, Copyrights, and Proprietary Information
The franchisor must disclose information about any patents, copyrights, and other proprietary information that is related to the franchise system.
15. Obligation to Participate in the Actual Operation of the Franchise Business
The franchisor must disclose what obligations, if any, franchisee owners must have in the day-to-day operations of the franchised business including whether or not they must work in the franchised business on a full-time basis.
16. Restrictions on What the Franchisee May Sell
The franchisor must disclose its control over what a franchisee may or may not sell as a part of the franchised business.
17. Renewal, Termination, Transfer, and Dispute Resolution
The franchisor must disclose and summarize the legal rights and obligations related to the renewal, termination, and transfer of the franchised business. This item must also include a summary as to how legal disputes must be resolved between the franchisor and franchisee.
18. Public Figures
The franchisor must disclose if there are any celebrities or other public figures that have been hired to promote the franchise system.
19. Financial Performance Representations
The franchisor can (but is not required to) provide information on unit financial performance.
20. Outlets and Franchisee Information
The franchisor must disclose the locations and contact information of existing franchises.
21. Financial Statements
The franchisor must disclose and include audited financial statements for the past three years.
Within FDD Item 22 franchisors must list and attach all contracts that a franchisee must sign with the franchisor. These include a sample of the franchisor’s standard franchise agreement and any related agreements such as a development agreement, site selection agreement, or release agreement.
The Franchisor must include two copies of the receipt page. This must be signed by the franchisee to confirm receipt of the document. This begins the 14-day review period.
What Is the FDD Disclosure Rule?
The FDD Disclosure rule requires franchisors to provide all potential franchisees with a disclosure document containing 23 specific items of information about the offered franchise, its officers, and other franchisees. This is in a bid to help prospective franchisees get up-to-date information to weigh the risks and benefits of making investments in franchises.
Is a Franchise Disclosure Document FDD Public?
According to the Federal Trade commission’s (FTC) rule, franchisors have an obligation to provide the franchisee with the FDD at least 14 days before it needs to be signed or before any initial money is exchanged. The franchisee has a right to a copy of the FDD after the franchisor has received the application and agreed to consider it.
How Do Prospective Franchisees Get a Copy of an FDD?
Franchisors may provide a copy of their franchise disclosure documents to prospective franchisees on paper, via email, or through a web page.
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