Get a handle on the terms before you invest in any opportunity.
Opinions expressed by Entrepreneur contributors are their own.
Q: I'm looking to buy a franchise, but I'm not sure what some of the terms mean. What's a UFOC? How is a master agreement different from an ADA? What are all these waiting periods for? Why do the feds restrict franchise companies from answering my questions about profit? Please advise.
A: Just like most industries, the franchising business has developed some communication shortcuts that can be confusing if you don't know what they mean. Some of the more common ones are listed below.
- The FTC. This stands for the Federal Trade Commission, the federal agency that sets many of the rules of conduct for franchise companies during the process of recruiting new franchisees.
- UFOC. This document, the Uniform Franchise Offering Circular, contains information that the franchisor must disclose to you before you buy a franchise. The FTC regulates the subject matter and format of this document to try to make the information as useful and comparable as possible.
- Franchise agreement. This is the contract that governs the relationship between you and the franchisor concerning the conduct of your business. The franchisor typically provides a brand, an operating system and support services to you and, in exchange, you pay the franchisor both initial and ongoing fees. The ongoing fees you pay a franchisor are often referred to as "royalty fees."
- Sub-franchisor and master license agreements. Some franchisors contract with entities to accept some or all of the franchisor's responsibilities for setting up and providing ongoing service to other franchisees. An entity that accepts this responsibility from the franchisor is usually referred to as either a sub-franchisor or a master licensee. These entities are typically paid a percentage of both the initial and ongoing fees in exchange for performing these duties.
- Area development agreements (ADAs) or multiple unit packages. These are development agreements that a franchisor executes for a multiunit development by a single franchisee. They typically cover a specified geographical territory and have a development schedule requiring a certain number of units be opened by the franchisee within specified time periods.
- Mandated waiting periods. A franchisor is required to provide a prospective franchisee with a UFOC document at least 10 working days before they can legally sell them a franchise. (You will always be asked to sign a receipt stating the date you received the UFOC for just this reason.) A franchisor is required to provide a prospective franchisee with a final form franchise agreement document at least five working days before they can legally sell them a franchise. This is to ensure that you have sufficient time to review these documents before making up your mind about the franchise.
- Earnings claims. The FTC defines an earnings claim by a franchisor to be any specific information about sales, expenses, profits, income, cash flows, etc. In a nutshell, the franchisor is forbidden from making any earnings claims to you unless it is in writing in the UFOC. If the franchisor does make an earnings claim in this manner, they are also allowed, under some circumstances, to make supplemental earnings claims as well to clarify or provide additional specific data to you. This rule was put in place in an attempt to protect consumers.
This gives you some general terms that you will hear all the time when you start investigating franchises. Always feel free to ask questions whenever you hear a term that isn't clear to you. Good quality franchisors will not have any problem answering your questions in detail and making sure that you fully understand what is going on with the franchise before you decide whether to buy it.