Purchasing a franchise is an excellent way to become a business owner while buying into an established brand. You’ll receive business guidance, marketing assets, training, and much more. However, while this is a great opportunity for you as an entrepreneur, you’ll want to make sure that you are making a sound business decision and are protected throughout the process.
This is where a Franchise Disclosure Document (FDD) comes into play. Here, we'll get a clearer picture of what this document is, review what it's used for, and offer some advice on when it's fit to sign. Let's jump in.
What is a Franchise Disclosure Document?
An FDD is a legal document that franchisors must present to franchisees before they complete their purchase. This document outlines 23 items that must be disclosed to franchisees including fees, the legal relationship, and the history of the company.
As a franchisee, make sure you receive this document and familiarize yourself with it. And be positive you're comfortable with everything it contains before you sign. It's better to find out you’re getting yourself into ahead of time than run into trouble one year down the road when it’s too late to do anything about it.
If you’re a franchisor, you’ll want to ensure that all of your legal ducks are in a row so you can present your best self to new franchisees.
What is a Franchise Disclosure Document used for?
This document allows franchisees to make an educated decision about the franchise system before entering into a business relationship. Potential franchisees must enter into this agreement with their eyes open, fully aware of what they are getting involved in.
When should a Franchisee receive a Franchise Disclosure Document?
The Federal Franchise Rule states 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.
When do you sign a franchise disclosure document?
Signing the FDD does not signify an agreement to buy a franchise. Rather, it begins the 14-day clock during which the potential franchisee can review the document and determine if they would like to engage in more serious talks about purchasing a business.
What information is given in an FDD?
The Franchise Disclosure Document includes 23 items designed to provide a thorough understanding of the franchise. It includes:
Item 1: The Franchisor and Any Parents, Predecessors, and Affiliates: A description of the company and its history.
Item 2: Business Experience: Business experience including the biographical and professional information of all franchisors and its officers, directors, and executives.
Item 3: Litigation: Information regarding current and past criminal and civil litigation for the franchisor and its management.
Item 4: Bankruptcy: Information regarding the franchisor and any management who have gone through bankruptcy.
Item 5: Initial Fees: The initial fees franchisees will incur in addition to the range and factors that determine the sum of those fees.
Item 6: Other Fees: A description of any other fees or payments that must be made.
Item 7: Estimated Initial Investment: The initial investment in table format and includes all expenditures required by the franchisee to establish the business.
Item 8: Restrictions on Sources of Products and Services: The restrictions that the franchisor has established regarding the source of products or services.
Item 9: Franchisee’s Obligations: The franchisor must disclose the franchisee’s obligations under the franchise agreement. This is presented as a reference table and includes a summary of all legal obligations to include (but not limited to) site selection, opening obligations, and any obligations upon termination of the franchise agreement.
Item 10: Financing: Whether or not the franchisor offers financing arrangements and, if so, what the terms and conditions of those arrangements are.
Item 11: Assistance, Advertising, Computer Systems, Training: The services that the franchisor will provide to the franchisee.
Item 12: Territory: This item requires the franchisor to disclose if the franchisee will be awarded a protected territory, how that territory will be determined, and any instances when the franchisor may operate with the franchisees’ territory.
Item 13: Trademarks: The franchisor must disclose any trademarks within the franchise system. This includes whether they are registered with the United States Patent and Trademark Office, their registration status, and whether there have been any notices of a trademark dispute or conflict.
Item 14: Patents, Copyrights, and Proprietary Information: This section dictates how the franchisee may use any patents and copyrights.
Item 15: Obligation to Participate in the Actual Operation of the Franchise Business: This item explains the obligations that the individual franchisee owner must have in the day-to-day operations of the business. This includes whether they must work in the franchised business full time.
Item 16: Restrictions on What the Franchisee May Sell: The franchisor must disclose what control they have over what can be sold as part of the franchised business.
Item 17: Renewal, Termination, Transfer, and Dispute Resolution: A disclosure and summary of the legal rights and obligations in regards to renewal and terminations and what the franchisee’s rights and restrictions are during a disagreement with the franchisor.
Item 18: Public Figures: Disclosure of any public figures (celebrities or public persons) used and the amount they are paid.
Item 19: Financial Performance Representations: The franchisor can (but is not required to) provide information on unit financial performance.
Item 20: Outlets and Franchisee Information: Locations and contact information of existing franchises.
Item 21: Financial Statements: This section includes audited financial statements for the past three years.
Item 22: Contracts: This item includes a list of all contracts that a franchisee must sign with the franchisor. The contracts are then attached as an exhibit. 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.
Item 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.
How often should a Franchise Disclosure Document be updated?
An FDD must be updated at the very least, annually, within 120 days of the franchisor’s fiscal year-end. If changes occur throughout the year that impact the FDD, it must be updated on a quarterly basis as soon as that information changes. This prevents misleading information from being disseminated to potential Franchisees.
Franchisors should submit their renewal well in advance of the 120-day mark as state examiners need to time review the registration application. This prevents the initial registration from expiring before the renewal is granted.
The Importance of a Franchise Disclosure Document
While buying into a franchise brand has its benefits for the eager entrepreneur, due diligence must be done to prevent challenges down the line. As a Franchisor, make sure that your FDD is up-to-date before beginning conversations with a potential Franchisee. This can save you legal fees and headaches down the line by clearly spelling out both sides' expectations early on.
To franchisees, fully utilize your 14-day window to examine the FDD and review it with an attorney if possible. If something seems unclear or potentially suspicious, ask for clarification — and don’t settle until your concerns have been dealt with. You are making a huge decision by purchasing into a Franchise and you want to make sure that your investment will pay off.