There are a few different documents you're likely to come across when you want to purchase a franchise. The franchise agreement is one of the most basic. It pretty much outlines your rights and obligations as a franchisee and the rights and responsibilities of the franchisor.
There is always a franchise agreement to review before the purchase of the franchise is completed, and a representative of the franchise will meet with you to sign it. You may also sign a non-disclosure agreement if needed, and the terms aren't included in the franchise agreement. An important document to review is the franchise disclosure document (FDD). You have the right to this document and should ask for it before deciding whether or not you want to make a franchise purchase. The franchisor is required to provide the FDD to you.
Elements of a Franchise Disclosure Document
What does the FDD tell you (the franchisee) about the franchise you want to purchase?
First, keep in mind that the FDD is a legal document. A franchisor has to disclose this document to any potential franchisee before the franchise is sold. The document includes 23 specific sections known as the "disclosure section." Under franchise laws, the franchisor is obligated to disclose information about the actual franchisor, about the franchise itself, about all the fees associated with the franchise, the legal relationship that will exist between the franchisor and franchisee, and a wide range of other specific information.
Under the Federal Franchise Rule
, the franchisor must disclose the FDD to a potential franchisee no less than 14 days before signing a franchise agreement or releasing any funds to the franchisor. Keep in mind that disclosure of the FDD is not enough on its own. The 14-day period is governed based on the day that the franchisee signs the FDD receipt page contained in Item 23 of the FDD. You should check with your state because, in certain states, the 14-day period has been changed.
The FDD List 23 Items You Should Be Wary Of:
- Item 1: The Franchisor (including parent companies and affiliates) — Is obligated to disclose their corporate information, including any affiliated business relationships and parent companies.
- Item 2: Business/Management Team — Franchisor has to disclose information about their management team. They do not have to disclose information regarding brokers who are involved in the sale.
- Item 3: Litigation — Franchisor must disclose litigation involving the franchisor, affiliates, or members of the management team as outlined in item 2.
- Item 4: Bankruptcy — Franchisor must disclose the franchisees, affiliates, predecessors, or management team members in Item 2 that have filed for bankruptcy.
- Item 5: Initial Fees — Franchisor must disclose all fees a franchisee will pay the franchisor before the franchisee opens for business. Common initial fees include initial franchise fees and assorted pre-opening fees, including inventory and equipment that are required to be purchased from the franchisor.
- Item 6: Additional Fees — Franchisor must disclose any other fees a franchisee is required to pay the franchisor during the terms of the franchise agreement. Common fees here include royalties, marketing, technology, training, and various other fees that the franchisee will pay to the franchisor.
- Item 7: Initial Investment Estimate — Franchisor is required to provide an estimated cost for a franchise, including opening and establishing the franchised business. This estimate includes everything, such as build-out costs to reserve capital for the first three months of operation and all costs relating to building and equipping the business.
- Item 8: Product and Supply Sourcing — Franchisor must disclose products and supplies the franchisee is required to purchase from the franchisor or suppliers designated by the franchisor. Franchisor also has to disclose any revenue or rebates earned from selling source-restricted products to franchisees.
- Item 9: Franchisee's Obligations — Franchisor is required to disclose the franchisee's obligations under the franchise agreement. This is done in a table format that will include a summary of legal obligations as they apply to site selection, the opening of the franchise, and the franchisee's obligations in the event of terminating the franchise agreement.
- Item 10: Financing — Franchisor must disclose if they offer financing to the franchisee.
- Item 11: Advertising, Computer Systems, Assistance, and Training — Franchisor must disclose any assistance and training the franchisor provides to the franchisee, any advertising obligations placed upon the franchisee, any computer and software systems required, etc.
- Item 12: Territory — Franchisor must disclose information regarding protected territory, if the initial territory is protected, how territories are figured out, and if there are exceptions that allow the franchisor to operate inside the protected territory.
- Item 13: Trademarks — Franchisor has to disclose information regarding trademarks and if they are or are not registered with the United States Patent and Trademark Office, the status of registration, and if the franchisor has notice of a trademark conflict or dispute regarding the franchise intellectual property.
- Item 14: Copyrights, Patents, Trade Secrets, Proprietary Information — Franchisor is obligated to disclose information about copyrights, patents, trade secrets, and proprietary information associated with the franchise system.
- Item 15: Obligation to Participate in the Operation of the Franchise — Franchisor must outline the obligations of individual franchisees regarding any required obligations they have in the day-to-day operation of the franchise.
- Item 16: Restrictions on Franchisee Regarding What They Can Sell — Franchisor has to inform franchisees of any restrictions on products and services they can sell as part of the franchise business or using franchise names, etc.
- Item 17: Renew, Terminate, Transfer, Resolving Disputes — Franchisor is required to disclose legal rights and obligations as it relates to renewing, terminating, or transferring of the franchise. This section has to include information regarding the settlement of legal disputes between a franchisor and franchisee.
- Item 18: Public Figure Endorsements — Franchisor must disclose any celebrities or public figures promoting the franchise system.
- Item 19: Financial Performance — Franchisor must disclose if they make any financial performance representations. If they do, the franchisor must provide specific details.
- Item 20: Outlets and Franchisee Information — Franchisor has to disclose in five tables a summary report of franchised and corporate outlets during the past three years and show a projection regarding the future opening for the upcoming year.
- Item 21: Financial Statements — Franchisor has to disclose, along with copies, their financial statements.
- Item 22: Contracts — Franchisor has to list and provide contracts that a franchisee must sign with the franchisor. These include the standard franchise agreement and other agreements to include site selection agreement, release agreement, etc.
- Item 23: Receipts — Franchisor must include two copies of the receipt page. This is the page a franchisee must sign to confirm proper disclosure and delivery of the franchise disclosure documents (FDD).
It's a good idea to have a lawyer specializing in franchise laws go over the FDD with you before you sign your franchise agreement. There are a lot of little details included in these 23 items that will dictate your ability to operate a franchise.
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