FDD and Me: What Are the 23 Franchise Disclosure Items?
The Federal Franchise Law and the franchise rules and regulations issued by the Federal Trade Commission govern a franchisor’s distribution and obligations in the disclosure of their Franchise Disclosure Document (FDD). In some states, franchise systems also have to register and get their FDD approved at the state level.
Every FDD must include these 23 disclosure items. Certain items, I believe, are more vital to your choice than others, and I have highlighted those below.
Item 1: The Franchisor
This item contains information about the franchisor, the franchisor’s parents, predecessors, and affiliates. This item includes important information that franchisees need to understand about the corporate structure of the franchise system (e.g. is it a corporation, partnership, LLC) and the existence of parent companies (is the franchise owned by a larger company).
Item 2: Business Experience
Item 2 contains information about the franchisor’s management team—including directors and principal officers. This will allow you to measure effectiveness of the franchisor’s management team and decide whether you would be provided with a competent support team. They do not, however, have to disclose the business experience of any brokers that are involved in the sale of its franchises.
Item 3: Litigation
This discloses information about the litigation history of the franchisor. Only pending lawsuits, suits involving the franchisor-franchisee relationship, prior lawsuits, and current government injunctive or restrictive actions have to be disclosed.
Item 4: Bankruptcy
Contains information on whether the franchisor, it’s parents, predecessors, or affiliates, or members of its management team have previously filed for bankruptcy.
Item 5: Initial Fees
Item 5 contains information about the up-front fees you’ll be required to pay before you open your business. The most important of these are the one-time initial franchise fee.
Item 6: Other Fees
This item discloses information about other fees, typically recurring or occasional fees, that you will be required to pay to the franchisor or an affiliate. These fees include royalty fees, advertising fees, and many others. These “other fees” will affect the operating costs of franchise and must be accounted for by the franchisee.
Item 7: Estimate Initial Investment
Franchisors are required to lay out clearly a potential franchisee’s total estimated initial investment to buy in and open a franchise. It contains a range of estimates as to the costs that a franchisee may incur in establishing and opening a new franchised location. The list is not prescribed by law, but includes the initial franchise fees, equipment expenses, training expenses, real property, beginning inventory, reserve capital requirements, and any other expenses that are required to get a franchised location up and running.
Item 8: Restrictions on Sources of Products and Services
Item 8 is important from an operational perspective. It contains information about the franchisee’s obligations to purchase or source goods, services, and supplies from company-specific suppliers. You should find included here detailed information about exclusive products or services and the franchisor’s designated and exclusive suppliers. This information is vital to understanding the supply chain and its costs to your franchise location.
Item 9: Franchisee’s Obligations
Contains information that details the franchisee’s legal obligations as per the Franchise Agreement. Item 9 must reference the Franchise Agreement or other relevant contractual documents. These legal issues include renewal rights, non-compete and confidentiality requirements, termination rights, and forum selection provisions.
Item 10: Financing
This item gives information about whether the franchise system can offer financing to its franchisees for fees listed in Item 5 and Item 6. For example, this item will tell you whether the franchisor will allow franchisees to pay the franchise fee over time, at what rate, and on what terms.
Item 11: Franchisor’s Assistance, Advertising, Computer Systems, and Training
This item references the franchisor’s obligations to assist and support the franchisee both prior to opening the business and after business begins as they are laid out in the Franchise Agreement. Vital to this assistance are the operating manuals and training programs, both of which are described here. This item also discloses important information about (mandatory) computer systems, software, and point of sale systems.
Item 12: Territory
Item 12 contains information about the exclusivity of the territory assigned to the franchisee. This item discloses whether a franchisee will be competing with other franchisees in the system and other channels of distribution, and whether the franchisor will allow the franchisee to relocate the business or establish additional businesses.
Item 13: Trademarks
Contains information about the status of the franchisor’s primary trademarks. It will disclose whether these trademarks are legally protected and registered with the United States Patent and Trademark Office. Item 13 should include other disclosures concerning any pending litigation regarding use of the trademark.
Item 14: Patents, Copyrights, and Proprietary Information
This item contains information about other intellectual property assets that the franchise system possesses. If a franchisor owns rights in or has licenses to patents or copyrights, then this must be disclosed in Item 14.
Item 15: Obligation to Participate in the Actual Operation of the Franchise Business
Discloses the franchisee’s obligation to personally participate in the day-to-day operation and management of the franchised business. If on-premises operation by the franchisee is not required, Item 15 must disclose any restrictions on whom they hire as daily management.
Item 16: Restrictions on what the Franchisee may Sell
Informs the franchisee about the level of control the franchisor has over what products or goods the franchisee can sell. Generally, franchisors restrict sales to franchisor-approved goods and services.
Item 17: Renewal, Termination, Transfer, and Dispute Resolution
This item contains a chart, cross-referenced to provisions in the franchise agreement, that summarizes the basic legal rights of franchisees in regards to renewal rights, termination of the franchise agreement, franchisee cure rights, non-compete obligations (both while operating the franchise and after), transfer or sale options, dispute resolutions, and choice of forum and choice of law provisions.
Item 18: Public Figures
Item 18 contains information on the franchisor’s payments to public figures for promotion of the franchise and indicated whether these public figures are a part of the franchisor’s management team or have invested in the franchisor.
Item 19: Financial Performance Representations
Contains representations from the franchisor about the historic or projected financial performance of the franchised outlets. Such representations of financial performance can only be made if the franchisor has a reasonable basis and written substantiation. Financial performance representations include, among other things, gross sales, EBITDA, and other financial metrics. Franchisors are not permitted to make financial performance representations unless they are specifically included in Item 19.
Item 20: Outlets and Franchisee Information
Contains statistical data tables (five are required) that summarize the franchisor’s corporate-owned and franchised outlets over the previous three-year period. The tables track the total number of locations along with the number of outlets that have been opened, closed, transferred, and terminated.
Item 21: Financial Statements
Item 21 requires disclosure of the franchisor’s financial statements from (at least) the two previous years that have been audited in accordance with generally accepted accounting principles. A franchisor’s parent company or affiliate company financial information may also be disclosed in some cases. New and start-up franchisors may have more limited financial statements that will be phased-in.
Item 22: Contracts
This item contains a list of all the legal agreements and contracts attached to the FDD. The primary contract is the franchise agreement, but leases, options, financing agreements, and purchase agreements may also apply.
Item 23: Receipts
Contains an acknowledgement of receipt that the franchisee must return to the franchisor to document receipt of the FDD. The receipt is in duplicate; the franchisee keeps one copy, the franchisor the other. Today, FDD’s are commonly delivered and signed electronically—with a PDF signature or unique password—and the franchisor’s receipt is an electronic acknowledgment.
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