Ohio Practical Business Law : Columbus Ohio Business Lawyer & Attorney : Teri Rasmussen : Plunkett Cooney Law Firm : Commercial Law, Creditors, Business Formation : Columbus, Central Ohio

I've blogged before (see below) about the decision to become a franchisee and what to look for in the disclosure documents the law requires be given to prospective franchisees.  However, I've noticed that there seems to be lots and lots of information out in the blogosphere and perhaps the bigger challenge is to figure out which information might be most useful.  Let me try to help. 

>>>>  Just as a cautionary note, you may wish to consider this recent Wall Street Journal article announcing that "Defaults by Franchisees Soar as the Recession Deepens".

For those still on the fence I ran across this article by Rick Bisio entitled "Franchise Ambush: Don't be Misguided by Advice from Others" in which he divides all the well-meaning advice you might be getting into 3 types:

• Advice that Helps - information gathered from actual franchisees and from professional advisors such as accountants and lawyers
• Advice that Disorients - perhaps your Great Aunt Edna or buddy who works for the post office
• Advice that Matters - Your spouse

The article also provides answers to some common questions you or others might ask about the decision to become a franchisee:

• Don't most small businesses fail?
• Why don't you just change jobs?
• Maybe you should think about it some more,
• What if you fail?

>>>>>>>>>>>

If you've definitely decided to become somebody's franchisee, here's some resources that may be helpful in making a decision about which franchise is right for you:

• The Wall Street Journal recently published an article entitled "Blogs Provide Insight to Would-Be Franchisees" which contained links to useful blogs and descriptions about their content.  

• Blue Mau Mau blog's tagline is "sharing franchise news, to prosper and amuse" and it delivers.  Great place to get information and recent news about specific franchises. 

• The Franchise King Blog authored by Joel  Libava promises "Franchise information, Franchise Trends, Tips, Traps, and truths, Tirelessly Delivered to the Kingdom" provides both information on specific franchises, particularly those active in Northeast Ohio, as well as more general information about franchise ownership.

• Business Exchange's Franchising topic contains current information of all sorts about franchsing and specific franchises and is associated with the Businessweek print magazine. 

• Franchise Times is a monthly publication with an on-line presence and calls itself "the news and information source for franchising",

• The Educated Franchisee website of Rick Bisio provides many useful general resources about becoming a franchisee.

• Franchise Direct blog has frequent posts containing news and information of interest to prospective franchisees.

• Make sure you understand the "10 Things Invesors Should Know About Buying a Franchise".

• Be aware of  "The Top Franchise Trends for 2009." 

•  Franchise Dimension  provides lots of general information about owning a freanchise, as well as information about a number of specific franchises and the opportunity to request more detailed information.

 PREVIOUS POSTS ON FRANCHISING

What a Franchise Disclosure Document (FDD) has to Say About the Role and Responsibilities of Franchisees

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

The New Franchise Disclosure Document

The Fanchising Route to Starting a Business

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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.

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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:

• Item 1 - The Franchisor and any Parents, Predecessors, and Affiliates
• Item 2 - Business Experience
• Item 3 - Litigation
• Item 4 - Bankruptcy
• Item 18 - Public Figures [Involved in Marketing Franchise] 

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:  

• Item 19 - Financial Performance Information [of Franchisees {Historical or Projected}]
• Item 20 - Outlets and Franchisee Information [Number Affected by Particular Events]
• Item 21 - Financial Statements [of Franchisor]

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

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 resources concerning  implementation of use of the new disclosure format.

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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:

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

• What a Franchise Disclosure Document (FDD) Has to Say About the Role and Responsibilities of Franchisees 

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Many a franchise, including Wendy's, White Castle, and Max & Erma's, got their start here in Columbus, Ohio where I practice business and commercial law.  So it is really not very surprising that budding entreprenuers in Central Ohio, as elsewhere, often consider a franchise opportunity when looking to start a business.

Concept and Information Availability.  Basically, the concept behind a franchise relationship is that in exchange for fees which can run into the several thousands of dollars, the franchisee new business owner receives the benefit of a proven business system and the associated experience.  And franchising may well be the way to go.  Franchisors often will provide resources and experience not otherwise available to a new business owner.  However, there will also be some loss of autonomy when it comes to how you run the business from day to day.

For better or worse, there is no shortage of information available regarding franchising.  (Interestingly, franchising is also apparently extremely popular in the Phillippines based on the results I got from the Google search I just did.)  But how do you know which information is reliable and correct?  How can you determine which franchise opportunity, if any, is right for you?

Begin by Assessing Personal Strengths and Weaknesses.  You should begin by taking a close look at yourself and weigh your strengths and weaknesses.  For example, are you a "team player"?  Because a franchise relationship is all about following someone else's system, you need to be able to picture yourself in that role.  Do you have particular knowledge about certain industries?  The Small Business Administration offers a helpful  "Is Franchising Right for Me?" workbook to help make this assessment.

Understand General Franchising Fundamentals.  Next you should make sure you understand at least the fundamentals of how franchising works.  Here again the SBA website excels in providing useful information on franchising and how to proceed if you are interested in this means of starting a business.  Entrepenuer.com's "Franchise Basics"  and "Franchise Terminology" posts also provide useful information about franchising, its terminology, and some of the details to which you should pay attention; other posts cover other questions on franchising. 

In addition, Mike Hamblin of the Michigan Business Lawyer Blog has written a four-part series on "Could a Franchise Be a Viable Opportunity for a Michigan Entreprenuer?" which provides a good overview of franchising, whatever state you live in:

• Part 1 - General Overview of Franchises (explaining the types of franchises available
• Part 2 - What Constitutes a Franchise? 
• Part 3 - Franchisors' Federal Disclosure Obligations [under the Uniform Franchise Operating Circular - more on that later]
• Part 4 - Franchisors' State Law Disclosure Obligations (Note that although Ohio Rev. Code 1334.02 does require certain disclosures with respect to "Business Opportunity Plans", these are not applicable to franchise opportunities offered in Ohio so long as they comply with federal disclosure requirements.)

Evaluate Specific Franchise Opportunities.  Once you understand the basic idea behind franchising and how it works in general, you are ready to start focusing more specifically on particular franchise opportunities.  How should you go about evaluating what's available?  What's important to look at? 

• The Small Business Administration provides an excellent Consumer Guide to Buying a Franchise on its website which does a great job of highlighting important issues to consider.  

• Rush Nigut of the Rush on Business blog (Congratulations Rush on your new position at Central Iowa-based Brick Gentry, P.C.) frequently posts on franchising.  He offers posts on "Fundamentals of Franchising - Franchisee's Perspective" and "Franchises: Four Things to Make You Go 'Hmm" which address certain "red flags" you should watch for and be wary of, as well as many other fine posts on the subject.

• The American Franchisee Association warns about "The Twelve Worst Franchise Agreement Provisions" you should avoid at all costs and also discusses "The Problems Franchisees Face" of which you should be aware.

There are also several good sources of information about particular franchise opportunities:

• Rush Nigut offers some suggestions in his "Looking for a Franchise?  Be Sure to Pick the Right Resources" post on the Rush on Business blog.

• The Franchise Law Blog published by the attorneys at Connecticut-based Wiggin & Dana LLP provides frequent news items about particular franchises that could be helpful in evaluating the viability of specific franchises.

• The Franchise King blog, published by self-described "Northeast Ohio's franchise guru" Joel Libava, is a bit more glitzy, but also offers information about specific franchises and going about evaluating them, as well as numerous links to other sources of information.  (This one took a little while to load on my home computer the first time I visited so you may need to be patient.)  

Read - Carefully - the Disclosure Documentation the Franchisor is Required by Law to Give You.  When you have narrowed the choice down to a couple of franchise opportunity possibilities, it's time to review (if you have not already done so) the disclosure documents provided by the franchisor as required by federal law.  Until recently, these disclosures were contained in a document called a Uniform Franchise Offering Circular.  Now being phased in and becoming mandatory after July 1, 2008, these disclosures will instead appear in a Franchise Disclosure Document.  The disclosures required will remain largely the same, but some additional information will be provided in a franchisor's Franchise Disclosure Document.

• Rush Nigut of the Rush on Business blog provides a relatively concise overview highlighting "Key Differences Between UFOC and New Franchise Disclosure Document".

• Take the time to listen to  "A Close Look at Pitfalls in the Franchise Disclosure Document" podcast.  This podcast features about a half hour interview of franchisor attorney Warren Lewis and franchisee attorney Julie Lusthaus and does a great job of presenting both perspectives.  It also does a tremendous job of explaining how the new Franchise Disclosure Document will differ from the UFOC, as well as the importance and usefulness of the various disclosures required - all in easily understandable language.  This is an excellent resource for anyone considering entering into a franchise relationship and is well worth the time to hear.   

• For those wanting a more technical discussion of disclosure requirements, visit the Federal Trade Commission's website.   

In many cases, entering a franchise relationship is a good option for someone wanting to start a new business, but apprehensive of possible consequences stemming from inexperience.  It can also be a way to jump start the path to profitability if you choose the right franchise.  However, it is extremely important to do extensive "due diligence" research to be sure you are making a good choice. 

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