The Franchise Disclosure Document (FFD) is an important legal document that franchisor’s must give to potential franchisees before signing a franchise agreement. The Federal Trade Commissions governs the contents of the FDD. The FTC rules cover twenty-three specific disclosure items.
A franchisor needs to provide the FDD (formerly known as the uniform franchise disclosure document) 14 calendar days before the potential franchisee pays any fees or signs a contract.
The Franchise disclosure document is a product of the dark days of franchising when salesmen would greatly inflate the sales projections upon unsuspecting business owners. The federal trade commission has required uniform disclosures since 1979.
It is paramount that any potential franchisee read the FDD before making a decision to purchase a franchise unit. The FDD covers important topics covered in the franchise agreement itself, but also reveals crucial information about the franchise system itself and the franchisor. The FDD advises potential franchisees of their obligations and rights before becoming a franchisee.
The following is an overview of all 23 items covered by the FFD.
1. The Franchisor and Any Parents, Predecessors, and Affiliates
This section reveals who the Franchisor is as well as its affiliates. Company-owned locations will also be identified. The goal of this section is to give a simple overview of the Franchisor so that the buyer will understand who the company is.
2. Business Experience
This section will explain who runs the franchisor and their underlying experience and background.
This section will disclosure litigation that the franchisor has been involved in regarding its franchisee relationship in the last fiscal year. This is an important area to reveal red flags in the business. Of course, context is important. It is common for large companies to have faced lawsuits. On the other hand, it may be a red flag for a smaller franchisor to be facing lawsuits.
Item 4 must state whether the franchisor or any of the individuals in item 2 have filed for bankruptcy in the last 10 years.
5. Initial Fees
This section will show the initial fees that must be paid to earn the right to become a franchise. Depending on the franchise system, this can be tens of thousands or more.
6. Other Fees
The item will disclosure other fees that a franchisee will be required to pay, including royalty fees and marketing fees.
7. Estimated Initial Investment
The investment items show how much a franchise can expect to expend to startup the business. This will often show a low-to-high investment range.
8. Restrictions on Sources of Products and Services
This section shows what the products or services the franchise may be required to buy, if at all. Insurance requirements will also be listed. The section will disclose any financial interests the Franchise may have in these arrangements.
9. Franchisee’s Obligations
Item 9 details the obligations the franchisee has to franchise. They include site selection and development, acquisition, lease, compliance, trademark, advertising, and indemnification. Franchisees need to review this list because failure to do so could result in a breach of their agreement.
It is rare to have a Franchisor provide financing. Occasionally, a franchisor may provide referrals for financing. If the franchisor receives commissions or referral fees they will be disclosed here.
11. Franchisor’s Assistance, Advertising, Computer Systems, and Training
Franchisors may sell goods and/or services to their franchisees, provided they disclose how they make money off such sales. Franchisors must disclose the amount of revenue earned from these required purchases.
This item will discuss how franchise territories are defined and protected. Franchisors are not required by law to provide exclusive or protected territory, but these are often covered subjects in a franchise agreement. A franchise should review this section carefully so they understand how secure their business will be from other franchisees in the system.
Pertinent trademark information will be found in Item 13. If there is litigation over marks or license agreement, this will also be disclosures. There will also be a discussion if there are special limitations on the marks or if there are others who can use the marks.
14. Patents, Copyrights, and Proprietary Information
Item 14 contains the same similar information as in Item 13, but it pertains to patents, copyrights and other proprietary information.
15. Obligation to Participate in the Actual Operation of the Franchise Business
Item 15 will cover important information on who may run the franchise business. Typically, this boils down to whether the franchise must be run by an owner-operator or a manager. The Franchisor must state whether it requires a manager to have an equity stake. Equity stakes, or similar compensation, are often encouraged to give the manager a strong incentive to perform better than a mere employee who takes a salary.
16. Restrictions on What the Franchisee May Sell
This section states what franchisees must use in order to stay compliant with the franchisee agreement. The requirements will vary from industry to industry. In so business, the franchise must buy directly from only approved vendors, whereas in others the is much greater freedom and little oversight. Much of this information is covered in Item 8 as well.
17. Renewal, Termination, Transfer, and Dispute Resolution
This section covers important information governing the closure and continuation of the franchise relationship. It also covers how disputes are resolved. This may include mandatory arbitration. Most franchise documents will be governed by a jurisdiction different than that of the franchisee’s location.
18. Public Figures
Item 18 requires disclosure of information about a public figure’s involvement in the franchise system. These include the figure’s role in the sales of franchisees, management of the franchise, and their own investment in the system. This does not cover a public figure who simply markets the franchise’s goods or services to the general public.
19. Financial Performance Representations
Item 19 is an important and valuable section to utilize in evaluating a franchise. However, franchisors are not required to provide financial performance representations (FPRs). Indeed some may not because of concerns about making representations that could be the focus of a lawsuit from a failed franchisee in the future. However, in the event that a franchisor does want to provide information regarding sales, earnings, or expenses, they will be discussed in this item.
Item 19 is also important in evaluating your financing and expansion strategy.
A franchisor should not be discussing any information about FPRs that is not contained in this section prior to the signing of the franchise agreement.
20. Outlets and Franchisee Information
This item contains a table summarizing the number of franchises that were opened, terminated, closed, and transferred over the past three years. Contact information for these units will be included. The closures are particularly important for a prospect to review as understanding why a unit closed is important evaluating the health of the system.
21. Financial Statements
Franchisor need to disclosure three years of audited financial statements. This item is useful to evaluate the franchisor’s financial health. Note, the FTC has a “phase-in” rule which permits startup franchisors to provide an unaudited balance sheet in the first year of franchising and an audited one in the second year.
All required contracts need to be disclosed. The franchise agreement itself will always be included. Additional documents will vary from system to system, but will often include lease riders, financing agreements, non-compete agreements, and personal guarantees (amongst others). It goes without saying that these should be reviewed carefully and with the assistance of legal counsel.
The last item is a receipt page to document when a prospect received the FDD and supporting documents.