Stick to the Path

Mining the UFOC

What a gold mine of information! A UFOC contains a sample copy of the franchise agreement, a set of financial statements to tell you about the financial health of the franchisor, and a running description (in plain English, no less) of the key aspects of the franchise investment:

  • The business background of the franchisor, and its key executives, as well as the company's litigation and bankruptcy history
  • The franchisee's fees and total initial investment
  • The purchasing requirements and product restrictions imposed on the franchisee
  • Financing offered by the franchisor, and other franchisor obligations under the franchise agreement
  • Your territorial, patent, copyright and trademark rights
  • A summary of provisions describing renewal, termination, transfer and dispute resolution
  • Earnings claims and system performance information
  • Statistics about the national franchise system, including a list of the names, addresses and telephone numbers of franchisees in your region

Read this important document. Get franchisor representatives to answer all your questions, and leave no stone unturned. Take the UFOC to your accountant and a good attorney, so you know exactly what you're getting into.

The single most important step in your franchise evaluation is to talk to current franchisees. Use the contact list in the UFOC, get in your car and visit their businesses. Find a convenient time to talk to the owners and find out what they like and don't like about being a franchisee.

How Uncle Sam Protects You
As a franchise buyer, you need Uncle Sam. Here's how the government helps to protect you from illegitimate franchises:

  • The Feds: For more than two decades, the FTC has been in the business of insisting that prospective franchisees receive full pre-sale disclosure. The FTC's Franchise Rule, adopted in the dark ages of the past century (OK, 1979), requires franchisors to deliver an offering disclosure document the size of a small phone book to every prospective franchisee at least a couple of weeks before the contract is signed. The intended result: fully informed franchise investors. Franchisors aren't required to register or otherwise file with the FTC; they satisfy the Franchise Rule by delivering full disclosure on time.

    The FTC may bring an enforcement action against any franchisor that doesn't meet its disclosure obligations or exhibits more serious problems. Most of its cases have targeted business opportunity sellers, not franchisors. The FTC's Web site is a great source of information.

  • Sale Regulation: Fourteen states require franchisors to deliver a pre-sale offering prospectus (the UFOC), register the offering with a state agency and renew the registration annually.

    These laws create a private right of action for investors injured by franchisors who don't comply with the rules, and the administering agencies (usually the attorney general or the securities agency) can provide information to investors about specific franchise companies. The franchise registration states are California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Rhode Island, South Dakota, Virginia, Washington and Wisconsin.

  • State Relationship Laws: Eighteen states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands have adopted laws that protect franchisees from arbitrary termination of their franchise without good cause. Under these laws, an injured franchisee has the right to sue for damages. The franchise relationship law states are Arkansas, California, Connecticut, Delaware, Hawaii, Illinois, Indiana, Iowa, Michigan, Minnesota, Mississippi, Missouri, Nebraska, New Jersey, South Dakota, Virginia, Washington and Wisconsin.

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This article was originally published in the January 2003 print edition of Entrepreneur with the headline: Stick to the Path.

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