The Franchise Disclosure Document
The Franchise Disclosure Document, also known as the FDD, is a mandatory legal prospectus that franchisors must disclose to prospective franchisees before a franchisee can sign a franchise agreement or pay a franchise fee. The FDD contains 23 disclosure sections, with each section referred to as an "Item."
What Are the FDD Disclosure Items?
The disclosure items contained in the FDD are mandated by federal and state franchise laws and include the following 23 items:
- Item 1: The Franchisor and any Parents, Predecessors, and Affiliates
- Item 2: Business Experience
- Item 3: Litigation
- Item 4: Bankruptcy
- Item 5: Initial Fees
- Item 6: Other Fees
- Item 7: Estimated Initial Investment
- Item 8: Restrictions on Sources of Products and Services
- Item 9: Franchisee's Obligations
- Item 10: Financing
- Item 11: Assistance, Advertising, Computer Systems, and Training
- Item 12: Territory
- Item 13: Trademarks
- Item 14: Patents, Copyrights, and Proprietary Information
- Item 15: Obligation to Participate in the Actual Operation of the Franchise Business
- Item 16: Restrictions on What the Franchisee May Sell
- Item 17: Renewal, Termination, Transfer, and Dispute Resolution
- Item 18: Public Figures
- Item 19: Financial Performance Representations
- Item 20: Outlets and Franchisee Information
- Item 21: Financial Statements
- Item 22: Contracts
- Item 23: Receipts
Ultimately, the FDD is one of the legal documents that you will need to franchise your business and sell franchises. Within those states known as the franchise registration states, the FDD must be filed and registered with a state franchise examiner.
When Does an FDD Have to Be Disclosed to a Franchisee?
Under the Federal Franchise Rule, the FDD must be disclosed to a prospective franchisee not less than 14 days prior to the prospective franchisee signing a franchise agreement or paying any money to the franchisor. Disclosure of the FDD by itself is not enough; commencement of 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. Certain states have modified this 14-day period. Learn more about the FDD disclosure period.
When Is an FDD Issued?
The franchisor and the franchisor’s lawyers determine the issuance date of the FDD, which is the date that the franchisor designates its FDD as being complete and in compliance with federal franchise laws. Compliance and the determination of the issuance date is a self-certifying process in that there is no federal agency that reviews or registers FDDs. However, at the state level, within the franchise registration states, the FDD must be registered with a state examiner who will, after a review process, grant or deny registration.
How Often Does an FDD Have to Be Updated?
The FDD must be issued and updated no less frequently than annually, within 120 days of the franchisor’s fiscal year end. However, if there are material changes in the information contained in the FDD, then the FDD must be updated on a quarterly basis or immediately for material or misleading information. Learn more about when the FDD needs to be updated.
Does the FDD Registration Have to Be Renewed?
Yes. Within the franchise registration states, FDD registration must be renewed on an annual basis within 120 days of the franchisor’s fiscal year end. Since state examiners will need time to review a franchisor’s registration renewal application, it is important for franchisors to submit their renewal applications well before the 120-day renewal deadline - otherwise a franchisor risks “going dark” in that state, whereby their initial registration expires before renewal is granted.
Every year, the FDD needs to be updated and FDD registrations must be renewed. To learn more about the franchise registration states and state-specific requirements for registering and filing an FDD, visit our interactive franchise registration map.
In What States Does the FDD Have to Be Registered?
When dealing with the franchise registration states, if (a) the prospective franchisee resides in a franchise registration state, (b) the franchised business will be developed and located within a franchise registration state, or (c) the franchisor is marketing/offering the sale of franchises in a franchise registration state, then the FDD must be registered in that state. Also, New York franchisors (i.e., franchisors incorporated in New York or who operate from New York) must register their FDDs in New York (in addition to the other states) whether or not the franchisee or franchised business is located in New York.
Does the FDD Have to Include Audited Financial Statements?
Yes. As a part of FDD Item 21, the FDD must contain audited financial statements of the franchisor. However, in most states, for new franchisors that have not previously offered or sold franchises, there is a partial financial statement phase-in exemption wherein a start-up franchisor may initially issue its FDD with an unaudited opening balance sheet. However, many registration states do not recognize this phase-in process. Learn more about the financial statements that have to be included in the FDD.
Does the FDD Have to Be Amended Before Negotiating Changes to a Franchise Agreement?
If during the franchise sales and negotiating process a franchisor makes changes to the franchise agreement, if those changes were negotiated changes requested by the franchisee and for the benefit of the franchisee, then the franchisor does not need to amend its FDD. Franchisors should be cautious as to negotiated changes to the franchise agreement, as FDDs most likely contain a representation that a franchise offering is “uniform” as to what the franchisor offers and grants to franchisees.
The FDD Also Discloses Relevant Business Information
Because the FDD is an integral part of the franchise sales process and is provided to prospective franchisees at the beginning of the franchise sales process, the FDD is also a business document that discloses to prospective franchisees the business underpinnings of your franchise.
When evaluating and comparing franchise systems, prospective franchisees and franchise brokers will compare and evaluate your FDD from a business perspective as to how well your franchise offering stacks up against your competitors. Consider some of the following business points:
- Within the FDD, you will be disclosing the type of franchise that you are offering, the initial franchise fee that you charge, and the ongoing royalties that franchisees will be required to pay to you. When developing your FDD, you very much need to consider the unit economics of your franchise offering, how your system stacks up against others, and whether or not your franchisees will have a fair shot at generating a good return on investment; and
- If prepared correctly, your FDD must be customized to your business and your franchise growth plan. When developing or updating your FDD, some of the business questions and points that you should address include:
- What Franchise Structure Are You Offering? Are you offering a single franchise opportunity where a franchisee establishes one operating unit, or do you have dual structure where a franchisee may also sign a development agreement and possess the right to establish, for example, up to three operating units?
- Do You Offer Multiple Development Opportunities? Does your franchise model and FDD support only one type of operating unit, or will a prospective franchisee have a choice in selecting the type of operating unit he or she wants to establish, i.e., a full-service location, or alternatively a more limited service express-type operating unit?
- What’s Your Royalty Structure? Are franchisees required to pay you a royalty fee that is a fixed percentage of gross sales, or have you adopted an alternate model of a fixed-fee royalty or possibly even a no-royalty structure?
- Do You Offer a Protected Territory? Are franchisees granted a protected territory? And if they are, how does your FDD and franchise agreement address issues involving competition between franchisees, and the use of digital and other media that is widely distributed? Are there exceptions for alternative channels of distribution?
To learn more about the FDD and franchising, read our Ultimate Guide to Franchising.
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