Uniform Franchise Offering Circular (UFOC)

If you’re interested in purchasing a franchise, you’ll want tobe sure to get a copy of their Uniform Franchise Offering Circular(UFOC) and review it from cover to cover. It’s after you’vecontacted a franchisor and filled out their questionnaires todetermine whether you fit the profile of “their kind” of franchiseethat you’ll receive two documents in the mail. One will be theUFOC, which contains 23 items of information about the franchise,and the other will be the franchise agreement. State and federallaws require that the franchisor give you these documents at least10 days before taking your deposit and signing you on as afranchisee. If you don’t receive them, you should be sure to askabout them.

Carefully examine the information in these documents beforeconsulting with your CPA and attorney. Just because these documentsappear to comply with the FTC rules and/or various state filingrequirements doesn’t mean they do or that the terms are in yourfavor. Most of those regulations only require the franchisor tomake complete and full disclosure of various categories ofinformation the law requires in the document. So long as thedisclosure is made in the proper manner, the franchisor can draftthe terms and conditions of its franchise and its obligations toyou as a franchisee in almost any manner it wishes.

The first section in the UFOC is a brief history of thefranchise. The history should document who founded the company,when it began doing business, incorporation dates if any, and whenit first started franchising. This data lets you know what kind ofexpertise and experience the franchisor has to offer. A franchisorwho has only been in business for a few years and began franchisinga year after start-up doesn’t have a lot of experience in thebusiness.

The next section discusses franchise fees and royalties. Thefront-end franchise fee and royalties are fully disclosed. Thecontinual royalty (usually monthly) may run up to 15 percent, andan additional advertising royalty may be 5 percent or more. Thefront-end franchise fee may be $1,000 to $300,000 or more. Itusually does not include the costs involved in actually startingthe business, such as inventory, equipment, facility, and leases.Make sure to include these fees in your financial projections, soyou can accurately gauge the business’ ability to generate profitsin the future.

Next is a section that contains a brief summary of the officers,directors, and other executives. Read carefully to determine theirlevel of experience and expertise. See if any have ties withsuppliers or vendors from whom you’ll purchase supplies orinventory and whether such ties present conflicts of interest.

The UFOC will also include a brief description of any majorcivil, criminal or bankruptcy actions that the officers andexecutives have been involved in or that the franchise company is aparty to. Lawsuits are common today, and the fact that someone hasbeen sued or has filed suit does not necessarily indicate problems.However, if the lawsuits involve problems with franchisees orvendors, or if they are numerous, investigate further to determinethe stability and integrity of the franchisor.

The terms of the franchise agreement are one of the most crucialparts of the UFOC and one that you need to review carefully. Manyfranchisors offer initial terms of five to ten years with optionsto renew for additional periods. However, it is not uncommon toencounter agreements for five-to-ten year terms with no option forrenewal. This means that when the initial term expires, thefranchisor may terminate the franchise and open his own companystore, or charge the franchisee a large fee to continue. If thefranchise agreement does not give you an option to renew, you haveno protection and could lose all the goodwill you built up duringthe period you operated the business.

Franchisors are required to list an approximation of the initialcosts of starting the franchise in addition to the franchise fees.Those costs usually include equipment, inventory, operatingcapital, and insurance. Keep in mind that these costs are estimatesand are not inclusive. In fact, many franchise litigationspecialists point out that franchisors show zero working capital oran unrealistically low figure. If there is a working capital figurelocated in Item Seven of the UFOC, ask if it includes operatingexpenses for the business until it is fully self-supporting,including an owner’s salary. When interviewing other franchisees,ask them what they consider sufficient working capital for thefirst year of operation. Most important, have your CPA help you puttogether your own estimates.

Although some franchisors will supply you with projections ofthe sales and expenses of a new franchise location, most won’t.This area is heavily regulated by the FTC to prevent franchisorsfrom making unfounded claims. Now, however, more franchisors arebeginning to provide projections. This shift in philosophy is dueto regulatory changes in the late 1980s, which provided guidelinesfor franchisors on how to present earnings information.

A large section of the UFOC lists the many reasons a franchisormay terminate before the contract expires. They include poorcondition of the location, failure on the part of the franchisee topay royalties in a timely manner, failure to supply an account, andexcessive customer complaints.

If you’re deemed a “good,” i.e. “profitable,” franchisee, thefranchisor will not use these clauses to end its relationship withyou. However, if the franchisor thinks it can operate the locationbetter than you can, or has a more desirable applicant for thelocation, it may use one of those reasons to attempt to terminateyou. Therefore, if you sign on, you must be careful to comply withall conditions that, if not met, permit termination.

Regardless of the UFOC provisions permitting termination, somestates have strong laws that can make it difficult for thefranchisor to terminate a franchise early. Much of the litigationbetween franchisors and franchisees involves attempts on the partof franchisors to terminate franchisees’ licenses prematurely.

Never assume that purchasing a franchise will give you anexclusive, protected territory. Many UFOCs state that you do notreceive an exclusive territory but that it is the “policy of thefranchisor” not to locate another franchise within three miles.However, “policies” can and do change. The UFOC may also say thatif the franchisor decides to open another location in your area,you have the right of first refusal to purchase the new location.Another common provision allows you exclusivity in an area only ifyour sales are maintained at a certain predetermined level.

Read carefully the sections outlining the franchisor’sresponsibilities to you. Usually those obligations includeproviding you with a training manual, picking a suitable location,training you and/or an employee, helping plan or attending thegrand opening, and offering some sort of continuing assistance withadvertising and managing the store. In addition, you usually havethe right to use certain trademarked symbols and names for the termof the franchise.

The UFOC usually includes only a general description of theduties the franchisor has to the franchisee. Therefore, beforesigning on, ask to see the manual, learn more about the training,and meet the franchisor’s personnel who are going to assist you.And, if you’re still interested, make sure to get your lawyer’s andCPA’s blessings before you sign on the dotted line.