Franchise

The 23 Items Your Franchise Disclosure Document Must Include

In Franchise Your Business, author and franchise consultant Mark Siebert delivers the ultimate how-to guide to employing one of the greatest growth strategies ever -- franchising. Siebert shares decades of experience, insights, and practical advice to help grow your business exponentially through franchising while avoiding the pitfalls. In this edited excerpt, Siebert discusses the key components of the franchise disclosure document and explains why certain items are included.  

After choosing to franchise your business, you'll need to provide your prospective franchisees with a franchise disclosure document (FDD) 14 calendar days prior to taking any fees or signing any contracts with them (or upon their reasonable request). Since you don't count the day you provide the FDD or the day it's signed, you're actually able to sign on Day 16. There's no need to file this document with any federal agency: Simply present the document to your prospect, and the countdown begins.

The original purpose of the FDD dates back to the days when fast-talking franchise salespeople would play fast and loose with the truth, resulting in a number of franchisees who would invest their life’s savings into franchises that would ultimately fail. In order to protect these “consumers,” the FTC promulgated the rule to more fully inform franchise buyers about the investment they were considering.

In essence, the FDD is just that. It's a document that is drafted in a prescribed format to provide your prospective franchisee with the information they need to make an informed decision. And while the quality and contents of these documents vary, each FDD is required to contain the following sections in this order:

1. The Franchisor and Any Parents, Predecessors, and Affiliates

2. Business Experience

3. Litigation

4. Bankruptcy

5. Initial Fees

6. Other Fees

7. Estimated Initial Investment

8. Restrictions on Sources of Products and Services

9. Franchisee’s Obligations

10. Financing

11. Franchisor’s Assistance, Advertising, Computer Systems, and Training

12. Territory

13. Trademarks

14. Patents, Copyrights, and Proprietary Information

15. Obligation to Participate in the Actual Operation of the Franchise Business

16. Restrictions on What the Franchisee May Sell

17. Renewal, Termination, Transfer, and Dispute Resolution

18. Public Figures

19. Financial Performance Representations

20. Outlets and Franchisee Information

21. Financial Statements

22. Contracts

23. Receipts

The exact content and format of each of these required disclosure items is specified in detail within the text of the FTC Rule, but some of the more relevant aspects are listed below:

Initial Fees and Other Fees

As a franchisor, you must disclose in these two sections any fees you'll be charging your franchisees. Hidden or undisclosed fees can be a source of disputes, so you'll want to be careful here.

Estimated Initial Investment

You'll need to provide your prospective franchisees with an estimate of their initial investment (often showing a low and high range), including an estimate that will cover their needed working capital. Be sure your range is realistic, as underestimating the high end of the range can also be a source of future disputes.

Restrictions on Sources of Products and Services

As a franchisor, you can sell goods and/or services to your franchisees, as long as you disclose that you (or an affiliated entity) are making money on the sales. You'll also need to disclose the amount of revenue you're deriving from any required purchases (including rebates from unaffiliated vendors). Again, the rule here is to be sure you fully disclose all forms of revenue you generate through sales to franchisees.

Territory

You're not obligated to provide your franchisees with an exclusive or protected territory, but if you choose to do so, you'll need to disclose it here. You'll need to carefully consider a number of potential business conflicts and reservations of rights in this section should you choose to grant a territory.

Financial Performance Representations

You're not obligated to provide your franchisees with any information on sales, earnings, or expenses (other than those outlined above). But if you choose to do so, you'd need to provide it in this section of your FDD.

While you're welcome to discuss any information on these elements with your franchisees after they've signed the franchise agreement, prior to the sale of a franchise, you'll only be allowed to discuss what you've included in your financial performance representation (FPR), along with appropriate supporting data. These FPRs don't have to be in the form of income statements and don't need to be prepared in accordance with GAAP, so there's a good deal of flexibility as to what you can choose to disclose. But the bottom line is, if you plan to provide information that can help a prospective franchisee derive an income statement, it needs to be included in Item 19.

Outlets and Franchisee Information

You must provide a table that will summarize, among other things, the number of franchises that were opened, the number of terminations, the number of franchises that were closed, and the number that were transferred over the past three years. You'll also be required to provide contact information for all the franchisees in your system along with the contact information of franchisees that left the system (for any reason) in the past fiscal year.

Financial Statements

You'll need to provide three years of audited financial statements (balance sheets, statements of operations, owner’s equity, and cash flows) as part of your FDD. Since most franchisors create a new business entity when they begin franchising, the FTC has developed a “phase-in” rule that allows a startup franchisor to provide an unaudited balance sheet in the first year of franchising and an audited one in the second year. Note: Some states haven't adopted this rule. Moreover, if the franchisor is a subsidiary of an existing entity (or has obligations guaranteed by another entity), you may need to provide audited financial statements of the existing entity. Be sure to get legal advice on this issue before setting up your franchising business.

Contracts

You'll also need to provide your prospects with any contracts they'll need to sign. These will certainly include your franchise agreement and may also include financing agreements, product supply agreements, personal guarantees, software licensing agreements, and many other contracts that may be specific to your situation.

Receipts

The final section is a receipt page for your prospect to sign so you can document when they received the FDD. In summary, your FDD will review the business decisions contained in your contractual relationship with your franchisees and provide them with additional information on you and the franchise that will aid them in making their decision. There are literally hundreds of issues that must be addressed, and the decisions behind those issues will ultimately dictate the franchisor’s success. The FDD, and the underlying franchise contract, are complex legal documents that should only be prepared by an experienced franchise attorney.