What a Franchise Disclosure Document (FDD) Has to Say About the Role and Responsibilites of Franchisees
So how do you find out what a franchisee actually has to DO? In my last post, I wrote about the parts of the new Franchise Disclosure Document (FDD) that focus on describing the franchise and the business opportunity it represents. Now I will focus on the portions of the FDD which delineate what will be expected and required of the would-be franchisee, both financially and legally. As before, I include links to the examples of each Item contained in the Franchise Rule Compliance Guide issued in May 2008 by the Federal Trade Commission. For a complete set of the sample pages contained in the Compliance Guide, click here.
Financial Investment Required by Prospective Franchisee; Financing
These sections relate to the amount of $$$ someone getting into the franchise business relationship with the franchisor will need to put up either initially or while the franchise arrangement continues. Although this might seem like a fairly straightforward set of disclosures, in reality, there is often a dizzying array of fees and other payments required (e.g. advertising allowances, renewal fees, royalties, training charges, transfer fees, etc.) and elaborate calculation formulas. And not everyone pays the same amount to get into a franchise system. Whether full and proper disclosure was made of all fees is also often a significant area of dispute in franchise litigation.
Items 5 and 6 relate to fees paid by the franchisee to the franchisor, but do not include payments to third parties such as utlities payments for telephone and electricity. Item 7 covers expenses involved in getting a franchise outlet off the ground; it includes both the payments detailed in Item 5, as well other outside expenses such as real estate acquisition or lease expense, equipment purchase or lease, signage, etc. and explains the likely manner payment will be required, i.e. lump sum or as incrurred.
The terms and conditions of any financing franchisors make available, directly or indirectly, to prosective franchisees must also be disclosed in Item 10.
- Item 5 - Initial Fees [Paid to Franchisor]
- Item 6 - Other Fees [Paid on Ongoing Basis to Franchisor]
- Item 7 - Estimated Initial Investment [to begin franchise operations]
- Item 10 - Financing [available from or arranged by franchisor for franchisee]
Basic Contractual Obligations of the Parties
If one is still interested in becoming part of a franchise after learning about the background of the franchisor and its key people, digesting the information provided regarding historical and anticipated financial performance, and understanding the financial commitment required, it's time to become familiar with the contractual obligations involved in the franchise relationship. Item 9 and Item 11 of the FDD contain the basic responsibilities franchisee and franchisor owe to each other. Other provisions address the geographic area which will belong to the franchisee, as well as the extent to which personal involvement in the day-to-day operation of the franchise outlet will be required of a franchisee, and the type and nature of any ancillary agreements required in connection with becoming a franchisee. Other procedural asects such as triggers for termination, options for renewal, transfer rules and dispute resolution procedures must also be disclosed. Item 23 specifies the form of acknowledgement the franchisor must get from the prospective franchisee that the FDD was timely and properly provided to the prospective franchisee.
- Item 9 - Franchisee's Obligations
- Item 11 - Franchisor's Assistance, Advertising, Computer Systems
- Item 12 - Territory
- Item 15 - Obligation to Participate in the Actual Operation of the Franchise Business
- Item 17 - Renewal, Termination, Transfer, and Dispute Resolution
- Item 22 - Contracts
- Item 23 - Receipts
Rules and Regulations Governing Operation of Franchise
Finally, there are several sections relating to restrictions imposed on the franchisee by the franchisor in conjunction with the franchise relationship. In addition to rules concerning the appropriate use of franchisor trademarks and other intellectual property, these provisions may place restrictions on franchisees regarding where inventory, services, or supplies necessary to the operatioon of the franchise may be obtained; the franchisee may be required to do business only with certain specified vendors. In addition, the franchisor is required to make certain disclosures regarding revenue received by affiliates of the franchisor as a result of these restrictions. The nature and extent of the franchisor's ownership rights in intellectual property, as well as any challenges to those rights, must also be disclosed. If the franchisor wishes to prohibit a franchisee from selling any products other than the franchisor's or to require a franchisee to offer all of thfranchisor's products for retail sale, that must also be disclosed.
- Item 8 - Restrictions on Sources of Products and Services
- Item 13 - Trademarks
- Item 14 - Patents, Copyrights, and Proprietary Information
- Item 16 - Restrictions on What the Franchisees May Sell
RELATED PREVIOUS POSTS ON MY BLOG:
- The Franchising Route to Starting a Business offers suggestions, insights, and links to more in-depth information about how to get started looking into the franchising option
- The New Franchise Disclosure Document provides links to the FTC's website and resorrces concerning implementation of use of the new disclosure format.
- What a Franchise Disclosure Document (FDD) Tells You About the Franchisor and the Franchise is a companion post to this one and focuses on the portions of the FDD related to the background and financial performance of the franchisor and franchisees within the franchise system.
