What can I learn from the Franchisor’s FDD?
Origin of the FDD
Prior to the 1960s, there was little franchising momentum in the US. However, after the success of McDonald’s, many other companies began to franchise their concepts and the franchise industry expanded rapidly. In 1979 the Federal Trade Commission’s FTC Rule went into effect. This rule required all franchisors submit to all potential franchisees a document called the Franchise Disclosure Document (FDD). The purpose of the FTC Rule was to provide enough information so the prospective franchisee could make an informed decision about purchasing the franchise.
The FDD serves as a protection for the individual against deciding based on information not supported by fact. The FTC Rule requires franchisors provide the FDD to the prospective franchisee at the earlier of the first personal meeting or 10 business days before the franchisee signs an agreement or pays any money. It also provides that the franchise agreement must be given to the prospective franchisee at least five business days before the franchisee signs any agreement or pays any money. A franchisor’s FDD must be updated on an annual basis, or sooner if certain conditions are met.
Items found within the FDD:
- History and Experience. The franchisor must provide you with a history of their past activities, especially as it relates to potentially negative information. This information must be provided not only for the company itself but also for all officers and directors. The information includes factors like the business experience of the company and its principles and any recent litigation or bankruptcy history for either.
- Financial Factors. The company must disclose to you the relevant financial terms of the franchise opportunity. This would include the initial franchise fees, other startup costs, and an investment range estimate for your total cost to get into business. The FDD must also disclose any other fees, such as the royalty, marketing, and renewal fees that the franchisee will have to pay throughout the life of their franchise.
- Obligations and Restrictions. The company must disclose the obligations of both you and the company under the terms of the franchise agreement. They must also spell out any mandated restrictions that you will operate under in terms of your purchasing options and behavior as a franchisee.
- Other Considerations. The company must also disclose relevant information on a number of other factors such as financing programs, territory, trademarks and patents, renewal or transfer provisions and public figures.
- Exhibits. The company must also provide other data including audited financial statements, current franchisee lists with contact information, franchisees who have left the system in the past two years (with contact information), contracts, and receipts.
- Earnings Claims. FTC rules leave it up to the franchisor whether they want to supply information about the earnings that can be achieved in their business. If a franchisor does want to provide financial performance representations, they must follow stringent rules on how this information can be given to a prospective franchisee. It is essential for the franchisor to make sure that the data provided is as accurate and representative as possible and they must also clearly label any assumptions or qualifications on the data provided. As a result, financial performance representations can take a variety of angles and approaches, so reviewing the background information is vital.
State Franchise Requirements
In addition to the laws that mandate disclosure, there are also some states that have passed specific laws to further protect franchisees in that state. These laws may add additional disclosures or rules about franchise agreement terms. As an example, there are several states that require that the legal venue for any dispute must be in their state rather than in the state where the franchise company is located. These types of additional requirements vary from state to state but any that are appropriate to your situation in your state should be disclosed in the FDD you receive.
The responsibility is yours
The most important point to remember regarding the FDD is that you need to read and understand the material that the franchisor is disclosing to you. The FTC has a requirement that these documents must be presented in understandable English so that the material should be clear. It won’t make any difference, however, if you don’t carefully review the material.
Make sure you take the time to study the information supplied to you and you’ll have a much better chance of making sure that these legal requirements serve their purpose of protecting and safeguarding your interests.
