Get Franchise Fit

Pumping Iron: Lifting the UFOC

Not many franchisors will deliver a disclosure document to you when you walk up to the trade-show booth. If you attend a sales presentation or a "discovery session," or speak one-on-one with a sales representative at a hospitality suite or some other off-site location, most companies will hand you a franchise disclosure document at that time. So just what is this document?

All franchising companies in the United States are required to deliver a complete disclosure document known as the Uniform Franchise Offering Circular, or UFOC, to a prospective franchisee a couple of weeks before money changes hands or the prospect signs a binding legal obligation. For anyone researching a franchise investment, this is an indispensable document. As soon as you become at all serious about a particular franchise, it's time to get a copy of the company's UFOC. Franchisors are not required by law to give you a UFOC until fairly near the close of the transaction, so it's your responsibility to request one earlier. Some companies wait until you come through headquarters on a visit; others allow you to view the document online. Either way, your goal is to get your hands on the UFOC so you can obtain a full picture of the program as early as possible.

Once you have the company's UFOC, read it carefully. If you're an old hand at corporate investing, the document will be vaguely familiar to you--it's based on similar disclosures required under corporate securities laws. If you're new to these documents or if it's been awhile since you cracked open a securities offering prospectus, you're in for a pleasant surprise: All UFOCs are written in plain English and organized along the same detailed outline.

Resistance Training: Crunching Numbers
A UFOC is basically broken into three parts: 1) a descriptive narrative describing 22 various important aspects of the franchise offering, 2) a copy of the contracts you sign when you become a franchisee, and 3) a set of the franchisor's audited financial statements (or those of the company guaranteeing the obligations of the franchisor).

Start at the back. An experienced accountant can tell you a lot about the financial health of the franchising company by reviewing its audited financial statement. Does it have the financial muscle to survive long enough to continue servicing your franchise business, or is it teetering on the edge of a financial abyss? How many franchisees paid royalties last year, and what was the rough annual average payment? Did the company make money from its operations last year, and how do the numbers compare to the previous two years? Are any disturbing trends buried in the numbers? If you're not conversant in number-speak, seriously consider getting professional assistance. You'll probably need an accountant to help with the establishment of your business anyway, so find one now, and have the UFOC's financials reviewed.

That brings us to the franchise contracts--everybody's favorite mental workout! A word of caution here: Your franchise agreement is not required to be written in plain English. It's typically quite long (30 pages of single-spaced verbiage is not at all unusual), and it will strike you as remarkably one-sided, seeming to favor the franchisor at every turn. Let a good lawyer help you review it. Find one who has experience working with small businesses, and let the lawyer explain how it affects your interests. If your lawyer finds 27 ways she would like to change the contract before you sign it, arrange a discussion with your franchisor representative to find out how the company handles negotiated-change requests. Some franchisors insist on their standard contract; others will negotiate. Generally, in my experience, the younger the franchise program, the more willing the franchisor is to negotiate. In any case, it's always better to have a lawyer on your team to help you assess the legal situation.

Shaping Up, One Item at a Time
Now that you have professionals working on the more complicated aspects of the UFOC, turn to the plain-English narrative description. The first few items (Items 1 through 4) tell you all about the franchise program and the franchisor, its identification, address, range of business activity, history, involvement in other franchise programs, its managers' business experience, and its litigation and bankruptcy background. This is key information for checking out the depth of the company's experience and the nature of any serious legal problems. Don't be surprised if you find a few civil cases or arbitration cases against franchisees disclosed in Item 3--running to court or arbitration to resolve a dispute is an inescapable part of modern business life, and franchises are certainly no different from other businesses. In fact, the franchise sector is more litigious than most business sectors.

The next few items in the UFOC (Items 5 through 10) lay out the fees and estimates of the new franchisee's total expenses and disclose whether the franchisor provides financing for any aspect of the investment. Item 7 is most useful among these items; it's a chart summarizing all the expenses you're likely to incur when you establish a new franchise business. Make sure your accountant sees this information--it will be useful in your financial planning.

Items 11 through 14 detail the services and rights the franchisor provides you as a franchisee--everything from assistance with your grand opening to training to the granting of trademark and patent rights. Territorial protection, an issue close to the hearts of most franchise investors, is described in Item 12.

Other items worth noting are Item 19 ("Earnings Claims") and Item 20 ("List of Outlets"). An earnings claim is any statement that conveys how your franchise will perform financially or how existing franchisees are performing. A franchisor cannot say, "These businesses generate at least $450,000 a year" (even if it's true) without making the statement in Item 19 and disclosing the reasonable basis for the statement and the assumptions that underlie the claim. Item 19 disclosures, which appear in an estimated 30 percent of all UFOCs, are therefore eagerly read by prospective franchisees. If the UFOC has no Item 19 statement, you must rely on the performance information provided by existing franchisees.

Item 20 lays out a statistical picture of the entire franchise system over the past three years. It includes a list of current franchisees as well as people who left the franchise system for any reason in the past fiscal year. Use this vital contact information when looking to interview franchisees about their experiences with the program.

Just as it takes a little sweat to get in shape, it also takes some hard work to find a franchise business that meets all your needs--but the rewards can be well worth it.

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This article was originally published in the October 2005 print edition of Entrepreneur's StartUps with the headline: Get Franchise Fit.

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