Posted on February 25, 2009 by Teri Rasmussen

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.  

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.

 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.  

 

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Posted on February 21, 2009 by Teri Rasmussen

What a Franchise Disclosure Document (FDD) Tells You About the Franchisor and the Franchise

Whether you're thinking of trying a franchise as a replacement for the corporate job you hate (or perhaps no longer have), or believe that you have the best business concept since sliced bread  which you now want to share profitably, understanding the new Franchise Disclosure Document (FDD or sometimes UFDD) is key.  As a prospective franchisee, this document is essential reading in the due diligence process of determining if the business venture embodied in a particular franchise would be profitable and otherwise 'right" for you.  If you're thinking you might want to leverage your successful business by franchising the concept, you need to understand the scope and complexity of the information you will be required to provide potential franchisees. 

In Part I of this two-part post, I focus on what the FDD does to explain what a particular franchise is all about (think of it as the "sales" aspect of getting into a franchise).  To do this, I

  • provide links to more in-depth resources regarding the FDD
  • give a basic overview of its contents
  • summarize the portions of the FDD related to information about the franchise opportunity, namely background and financial performance information. 

In Part II, I explore the other sections of the FDD which relate primarily to what is and will be required of the franchisee (think of it as the operational side of what it will mean once you ARE a franchisee), namely

  •  the monetary financial investment required to be made by the franchisee both initially and on an ongoing basis
  • the basic terms of the contractual relationship that will be the franchise arrangement,
  • other operational rules with which the franchisee will be expected to comply.

Resource Links.   For those with the need or desire to understand in detail the legal basis for use of the FDD (found in 16 CFR 436) or wanting more extensive resources, I highly recommend visiting the Guidance Documents page on the  FTC website.  For the rest of us seeking a more practical treatment, the Franchise Rule Compliance Guide issued in May 2008 by the Federal Trade Commission is invaluable.  As an aid to understanding the nature of what the FDD contains, I have attached links to the examples contained in this publication throughout this post (and its continuation in my next post).  For a complete set of the sample pages contained in the FTC Compliance Guide, click here. 

If you're trying to put a FDD together, another helpful resource is the 2008 Franchise Registration and Disclosure Guidelines, together with the related Commentary, put out by the North American Securities Administrators Association, Inc. (NASAA).  These materials answer practical questions about the kinds of information that must be included.  They can also be useful in gaining a better understanding of what the FDD is designed to accomplish. 

Overview of FDD.  The FDD is required to be written in "plain English" and in case anyone is in doubt as to what that means, section 436.1(b) of the amended FTC Franchise Rule defines it as:

the organization of information and language usage understandable by a person unfamilar with the franchise business.  it incorporates short sentences; definite, concrete, everyday language, active voice, and tabular presentation of information, where possible.  It avoids legal jargon, highly technical business terms, and multiple negatives.

However, just because the FDD is required to be written in "plain English" doesn't mean it will be all that easy to digest and comprehend (or to prepare).  By the time you get through all of its informational sections and all of the attachments, you are talking about one thick document easily the size of a large phone book.  ALL OF IT IS IMPORTANT AND CRUCIAL TO UNDERSTAND!!!  

Although there are technically twenty-three separate sections of the FDD, for purposes of understanding what information can be obtained by reviewing the FDD, it can be divided into five main parts (for a brief and slightly differently organized summary, visit this U.S. News and World Report post on The Anatomy of an FDD):

  • Background Information about the franchise, its ownership, and key management employees, as well as recent involvement in litigation
  • Financial Performance Information about the Franchise, existing franchise outlets, and hypothetical new franchise outlets 
  • Franchisee Required Financial Investment and Available Financing
  • Basic Contractual Rights and Resposibilities of Franchisor and Franchisee
  • Operational Rules and Regulations with which franchisees must comply in running their particular franchise outlet

Cover Page:

The new FTC Rule prescribes a particular format that must be followed EXACTLY by the franchisor to provide certain specific information on the cover page of the FDD.  In addition to the expected contact information and brief description of the nature of the franchised business being offered, the cover page must reference the FTC's Consumer's Guide to Buying a Franchise and include a sample of the primary business trademark required to be used in the operation of the franchised business.  In addition, both the initial investment described in more detail in Item 5 of the FDD and the total investment described in more detail in Item 7 of the FDD must be disclosed on the cover page.  There is also an "issuance" or 'effective" date listed on the cover page and language explaining how a prospective franchisee can obtain the FDD in another format.  

Background:

The first four sections of the FDD essentially provide background information about the franchise and its principals and management.  This information includes the business experience of the franchisor's key individuals in management, as well as the involvement of those individuals and the franchise itself in litigation as far back as 10 years in some instances.  In a change from the old Uniform Franchise Offering Circular (UFOC), franchisors are now required to disclose, by category,the number of legal actions initiated by the franchisor against franchisees, which involved the franchise relationship, in the immediately preceding fiscal year.  In addition, if any celebrity or other "public figure" is involved in the advertising and promotion  of the sale of the franchise, certain disclosures concerning the nature and extent of that individual's investment and/or management control must be made.  These sections are interesting and should not be overlooked, but they are not the most crucial part of the FDD,  These background sections of the FDD are:

Economics of Franchise Ownership - Financial Information About the Franchise and Existing Franchisees

Perhaps the most important, and certainly one of the most complicated parts of the FDD are the sections dealing with the recent and anticipated financial performance of the franchise, i.e. "how much money will I make?".  Franchisors are not required to provide any information about projected financial performance, but if they do, it must have a "reasonable basis" and the basis and assumptions pertinent to the representations made must be included in the disclosures required.  These portions of the FDD provide information about the franchisor, the franchise system as a whole, and at the individual franchisee level.  They include:  

 Next post will deal with remaining items of FDD and what they have to say about the franchisee's obligations.

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Posted on September 6, 2008 by Teri Rasmussen

The New Franchise Disclosure Document

Beginning this past July 1, franchisors were required to provide information to would-be franchisees in a new format.  The Franchise Disclosure Document (FDD) has now replaced the Uniform Franchise Offering Circular (UFOC) as the vehicle by which potential franchisees are told of the benefits and risks of a particular franchise. 

Here is the complete text of the new amended new rule.  For those with less familarity with franchising who want to fully understand the rules, the Federal Trade Commission's Statement of Basis and Purpose may be especially helpful. 

I've previously posted on The Franchising Route to Starting a Business, including several links  to general resources for evaluating franchise opportunities and specific information about how the new FDD differs from the old UFOC.  In this post, i want to focus more specifically on the new FDD. 

The Federal Trade Commission's website offers a helpful FAQ about the new rule.  In addition, this past May, the Federal Trade Commission (FTC)  issued a lengthy, but very comprehensive and informative Amended Franchise Rule Compliance Guide.

The Compliance Guide begins by explaining what sort of business relationships constitute a franchise subject to the FTC Amended Rule and the process required for furnishing the required documentation.  It also explains the sort of information which must be included and that which is prohibited.  The lion's share of this 154 page document consists of an explanation of each of the FDD's required items and includes specific examples of how each item should be completed with sample disclosures and disclosure formats.  It also specifies the differences between the UFOC and the FDD with respect to the information now required,  In short, whether franchisor or franchisee, this is an extremely useful publication. 

Here is another example of a sample Franchise Disclosure Document.

>>>>> UPDATE>>>>>

For a more detailed examination of the contents of the new Franchise Disclosure Document, read these posts on my blog:

 

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