What is a Franchise Disclosure Document and What Should be Included?

A franchise disclosure document is an essential piece of paperwork when starting a franchise. But what is a franchise disclosure, and what should be included?

Entering a franchise business can be a great way to start your small business. By being a franchisee, you don’t necessarily need business experience to run a franchise. Franchisors will usually provide the training, resources, and support you need to operate their business model.

As a franchisee, you will however need to pay an initial franchise fee to the franchisor for the rights to use their brand in addition to ongoing franchise fees for marketing, royalties, and more.

Before entering an agreement with a franchisor, you must go through the Franchisor’s Franchise Disclosure Document (FDD). An FDD is a legal disclosure document that is provided to individuals interested in buying a franchise as part of the pre-sale due diligence process.

In simple terms, it gives a clear picture of the business relationship between the franchisee and the franchise.

• READ MORE: See our Franchise Guide

What Is a Franchise Disclosure Document?

A Franchise Disclosure Document (FDD) is a document required by the Federal Trade Commission that sets clear guidelines for the franchise relationship. It is a legally-required document that a franchisor provides to prospective franchisees. It discloses important information about the franchisor.

Franchise agreements may vary between different franchises, but often include sections such as the use of trademarks; location of the franchise; general terms of the franchise; franchisee’s fees and other payments; obligations and duties of the franchisor; restriction on goods and services offered; and renewal, termination and transfer of franchise agreement.

Core Purpose of FDD:

• Sets guidelines for the franchise relationship.
• Legally required document.
• Discloses vital information about the franchisor.

What Is an FDD in Business?

Franchise Disclosure Document (FDD) helps to provide prospective franchisees with information about the franchisor, the franchise system, and the agreements they will need to sign so that they can make an informed decision. The Federal Franchise Rule requires that the FDD must be disclosed to a potential franchisee no less than 14 days prior to them signing a franchise agreement or paying any money to the franchisor.

Once the prospective franchisee signs the FDD receipt page (item 23 of the document), the 14-day period begins. According to the law, every FDD must include 23 disclosure items.

What Should Be Included in an FDD Franchise Disclosure Document?

Under the FTC’s Amended Franchise Rule, a franchisor selling a franchise must include twenty-three (23) items in its FDD. While the contents of each item may vary with each franchisor, each FDD is required to contain the following items in this order:

1. The Franchisor and any Parents, Predecessors, and Affiliates

A franchisor is obligated to present a comprehensive profile of itself. This entails elaborating on the evolution and trajectory of the company, including its inception date, pivotal moments, and significant growth phases.

Furthermore, it’s crucial to illuminate the relationships and distinctions between the franchisor, parent companies, predecessors, and any affiliate organizations.

An understanding of the business model and core concept that the franchise offers, an analysis of the current and potential market, any pertinent government regulations the franchisee must adhere to, and an overview of potential competitors in the sector should also be presented for clarity.

2. Business Experience

Transparency regarding the experience and qualifications of those steering the franchisor company is essential. This section should detail the professional backgrounds of the franchisor’s senior management team.

Highlight their roles, accomplishments, durations in their respective positions, and their relevance to the franchise industry.

Similarly, provide an overview of the franchise sales representatives and the team responsible for franchisee support, emphasizing their proficiency and experience in assisting new and existing franchisees.

3. Litigation

Full transparency is imperative when it comes to legal entanglements. The franchisor should enumerate all significant legal proceedings they’ve been involved in, spanning from civil lawsuits to criminal actions.

The nature of the case, the parties involved, the timeline, and the outcome, especially if it impacts the franchise’s operations or reputation, should be detailed.

Both ongoing and concluded litigations are pertinent, and the franchisor’s role in these—whether as an accuser or defendant—must be explicitly defined.

4. Bankruptcy

It’s crucial for prospective franchisees to be aware of any past financial pitfalls the franchisor might have encountered.

Therefore, the franchisor is obligated to divulge if it or any closely affiliated entities, including predecessors or management personnel highlighted in ‘Item 2’, have ever declared bankruptcy.

The circumstances surrounding the bankruptcy, the date it was declared, and the ramifications and recovery efforts following it should be laid out comprehensively.

5. Initial Fees

Financial clarity is paramount for potential franchisees. The franchisor must provide a detailed breakdown of all initial costs associated with launching the franchise.

This includes franchise fees, training costs, equipment purchases, and any other expenditures the franchisee must incur before operations commence.

Additionally, a clear timeline should be established for when these fees are due, along with stipulations regarding refundability, terms of payment, and any potential scenarios where additional charges might be levied.

6. Other Fees

Apart from the initial fees, franchisees should be aware of the recurrent or occasional fees they might need to pay during their tenure as franchise holders. The franchisor should provide a transparent breakdown of such costs.

This might include royalties (which could be a fixed fee or a percentage of revenue), contributions to marketing or advertising funds, technology or software licensing fees, training refreshers, and any other brand-specific charges.

It’s essential to specify the frequency (e.g., monthly, annually) and any factors that might lead to variations in these fees.

7. Estimated Initial Investment

Potential franchisees must have a clear financial roadmap to comprehend their initial commitment. The franchisor should present an itemized list of all potential expenses a franchisee might incur while setting up the business.

This would encompass costs like leasehold improvements, equipment and inventory procurement, licensing and permits, professional fees (like legal or accounting), and even initial marketing efforts.

Additionally, considering the business might not be profitable from day one, franchisors should also estimate the working capital needed to keep the business afloat for its initial months.

8. Restrictions on Sources of Products and Services

In franchising, brand consistency is paramount. Therefore, franchisors often mandate where franchisees source their products or services. This section should clearly list out any products or services the franchisee is obligated to purchase directly from the franchisor or specified suppliers.

Moreover, if the franchisor benefits financially from these arrangements, like receiving rebates from designated suppliers, such monetary gains must be openly disclosed.

9. Franchisee’s Obligations

Ownership of a franchise comes with a series of responsibilities to maintain brand integrity and operational standards.

The franchisor should provide a clear overview of these expectations. This encompasses all stages of the franchise lifecycle, from initial location scouting and establishment to the daily operations. In case of any breaches, the legal repercussions, potential penalties, or remedial actions required should be specified.

Additionally, if the franchise agreement were to be terminated, either due to its natural conclusion or other circumstances, the responsibilities and obligations of the franchisee during the winding-down phase should be detailed.

10. Financing

Starting a franchise can be capital-intensive, and potential franchisees might seek financial assistance. If the franchisor provides any in-house financing options, these should be extensively detailed in this section.

This would encompass the types of costs the franchisor is willing to finance (like franchising fees or equipment purchases), the terms of the loan, interest rates, repayment schedules, and any prerequisites or qualifications the franchisee must meet.

If the franchisor doesn’t offer financing but has partnerships with external financial institutions that do, those should be highlighted here.

More Important Information to Put in a Franchise Agreement

The franchise disclosure document (FDD) previously known as the Uniform Franchise Offering Circular (UFOC) is a legal disclosure document that must be given to individuals interested in buying a U.S. franchise as part of the pre-sale due diligence process.

Additional items required by law to be included in the FDD include:

11. Assistance, Advertising, Computer Systems, and Training

The franchisor must disclose the type of assistance and training that it would provide to the franchisee. In addition to the advertising requirements to be imposed on the franchisee, and the required computer and software systems that the franchisee will be required to purchase and utilize.

12. Territory

The franchisors must disclose if the franchisee will be awarded a protected territory, whether or not the territory is protected, how the territory will be determined, and instances where the franchisor reserves the right to operate within the franchisee’s territory.

13. Trademarks

The franchisor must disclose information about the trademarks of the franchise system, including, whether or not they are registered with the United States Patent and Trademark Office, their registration status, and whether or not the franchisor has notice of a trademark conflict or dispute.

14. Patents, Copyrights, and Proprietary Information

The franchisor must disclose information about any patents, copyrights, and other proprietary information that is related to the franchise system.

15. Obligation to Participate in the Actual Operation of the Franchise Business

The franchisor must disclose what obligations, if any, franchisee owners must have in the day-to-day operations of the franchised business including whether or not they must work in the franchised business on a full-time basis.

16. Restrictions on What the Franchisee May Sell

The franchisor must disclose its control over what a franchisee may or may not sell as a part of the franchised business.

17. Renewal, Termination, Transfer, and Dispute Resolution

The franchisor must disclose and summarize the legal rights and obligations related to the renewal, termination, and transfer of the franchised business. This item must also include a summary as to how legal disputes must be resolved between the franchisor and franchisee.

18. Public Figures

The franchisor must disclose if there are any celebrities or other public figures that have been hired to promote the franchise system.

19. Financial Performance Representations

The franchisor can (but is not required to) provide information on unit financial performance.

20. Outlets and Franchisee Information

The franchisor must disclose the locations and contact information of existing franchises.

21. Financial Statements

The franchisor must disclose and include audited financial statements for the past three years.

22. Contracts

Within FDD Item 22 franchisors must list and attach all contracts that a franchisee must sign with the franchisor. These include a sample of the franchisor’s standard franchise agreement and any related agreements such as a development agreement, site selection agreement, or release agreement.

23. Receipts

The Franchisor must include two copies of the receipt page. This must be signed by the franchisee to confirm receipt of the document. This begins the 14-day review period.

Franchise Disclosure Document (FDD) Checklist

When reviewing an FDD, it’s essential to ensure all mandatory components are present. Use this checklist to guide your review:

Why Are Franchise Disclosure Documents Important to a Franchise Business?

The FDD lets prospective franchisees analyze and decide if they want to purchase a franchise. It also provides an opportunity to know more about the franchisor, its legal history, company structure, financial status and agreements, existing franchisees, franchisee’s obligations, initial fees required, and more.

Importance of FDD:

• Helps franchisees analyze the franchise opportunity.
• Details about franchisor’s legal history, company structure, etc.
• Franchisee’s obligations, initial fees, etc. are clearly outlined.

Strategic Insights from an FDD

While the FDD provides a legal framework and operational details, prospective franchisees should also look for strategic insights hidden within the document.

This includes understanding the franchisor’s growth strategy, market positioning, competitive landscape analysis, and how these factors might affect the franchise’s potential success.

Analyzing historical performance data of existing franchises, disclosed within the FDD, can offer valuable benchmarks for what new franchisees might expect in terms of revenue and profitability.

Navigating the Franchisor-Franchisee Relationship

The FDD is also a window into the franchisor-franchisee relationship’s dynamics. Prospective franchisees should carefully review the obligations, restrictions, and support outlined in the document to gauge how the franchisor views its relationship with franchisees.

This includes evaluating the franchisor’s commitment to training, marketing support, ongoing operational guidance, and conflict resolution. Understanding these aspects can help franchisees anticipate the level of autonomy and support they will receive in operating their franchise.

Critical Evaluation of FDD Content for Informed Decision-Making

Prospective franchisees must approach the FDD with a critical eye, not only verifying the factual accuracy of the information provided but also assessing the implications of the disclosed terms.

This involves a thorough review of financial statements to assess the franchisor’s financial health, litigation history to identify any red flags, and the specifics of initial and ongoing fees to ensure they align with the franchisee’s financial planning.

Additionally, prospective franchisees should consider seeking legal and financial advice to fully comprehend the FDD’s terms and implications for their investment.

What Is the FDD Disclosure Rule?

The Franchise Disclosure Document (FDD) Disclosure Rule, enforced by the Federal Trade Commission (FTC), is designed to ensure that potential franchisees receive essential information about the franchisor, the franchised business, and any related contractual agreements in a standardized format.

This rule is meant to foster transparency, protect prospective franchisees from deceptive franchising practices, and allow them to make well-informed decisions.

Is a Franchise Disclosure Document FDD Public?

While the FDD is given to prospective franchisees as a part of the franchising process, it isn’t classified as a public document in the same way as government records. However, once provided, there’s no prohibition against a franchisee sharing their copy.

Additionally, in some states, franchisors must file their FDDs with the state’s regulatory body, making it possible to request a copy through public record inquiries.

Furthermore, many professional services and online platforms may have collections of FDDs that they’ve acquired and offer for research or comparative purposes.

How Do Prospective Franchisees Get a Copy of an FDD?

When a prospective franchisee shows genuine interest in a franchise opportunity and has initiated the franchising process, the franchisor is obligated to furnish them with the FDD.

This can be in hardcopy, or as technology has evolved, franchisors have been permitted to use electronic methods, like email or dedicated web portals, to deliver the document.

Additionally, some states may require that a franchisor provide the FDD upon request even if the franchisee hasn’t started the formal franchising process.

Regardless of the method used, the key principle behind the FDD’s delivery is ensuring that the potential franchisee has ample time and opportunity to review and understand the contents before committing to any agreements.

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This article, "What is a Franchise Disclosure Document and What Should be Included?" was first published on Small Business Trends