What is a Franchise Disclosure Document (FDD)?
A Franchise Disclosure Document, also known as an FDD, is a legal document that a franchisor must disclose to a prospective franchisee before a franchise may be sold. The FDD contains 23 disclosure sections that, under the franchise laws, require a franchisor to disclose information about the franchisor, the franchise opportunity being sold, fees charged by the franchisor, the legal relationship between the franchisor and franchisee, and other information about the franchise offering.
Below we discuss the FDD in more detail including, what must be included in an FDD, when an FDD must be disclosed to prospective franchisees, and when an FDD must be updated and registered.
What Information Must Be Disclosed in An FDD?
Under the federal and state franchise laws an FDD must include 23 sections with each section referred to as an “Item.” Below is a summary of the 23 disclosure items of an FDD:
- Item 1: The Franchisor and any Parents, Predecessors, and Affiliates – Within Item 1 the franchisor must disclose its corporate information, including information about affiliated and parent companies of the franchisor.
- Item 2: Business Experience – Within Item 2 the franchisor must disclose information about the franchisor’s management team.
- Item 3: Litigation – Within Item 3 the franchisor must disclose certain types of litigation that currently involves or previously involved the franchisor, the franchisor’s affiliates, predecessors, and/or individual management team members identified in Item 2.
- Item 4: Bankruptcy – Within Item 4 the franchisor must disclose whether or not the franchisor, the franchisor’s affiliates, predecessors, and/or individual management team members identified in Item 2 previously filed for bankruptcy.
- Item 5: Initial Fees – Within Item 5 the franchisor must disclose all upfront fees that a franchisee must pay to the franchisor before the franchisee opens the franchised business. The most common initial fees disclosed in Item 5 include the initial franchise fee and other upfront pre-opening fees that may be paid to the franchisor such as fees for opening-inventory and equipment that must be purchased from the franchisor.
- Item 6: Other Fees – Within Item 6 the franchisor must disclose all other fees that a franchisee must pay to the franchisor throughout the terms of the franchise agreement. These fees typically include on-going royalties, brand development fund, marketing, technology, training, and other fees specific to the franchisor.
- Item 7: Estimated Initial Investment – Within Item 7 the franchisor must include a low to high estimate of the estimated cost for a franchisee to establish and open the franchised business. This estimate must include everything from build-out costs to reserve capital for the first three months of operation. The biggest expenses in Item 7 relate to expenses related to building-out and equipping the franchised business.
- Item 8: Restrictions on Sources of Products and Services – Within Item 8 the franchisor must disclose what products and supplies the franchisee must purchase from the franchisor or the franchisor’s designated suppliers. Within Item 8 the franchisor must also disclose revenue and rebates that the franchisor earned from selling source-restricted supplies and products to franchisees.
- Item 9: Franchisee’s Obligations – Within Item 9 the franchisor must disclose, in table format, the franchisee’s obligations under the franchise agreement. This table includes a summary of all legal obligations ranging from site selection and opening to default provisions and the franchisee’s obligations upon termination of the franchise agreement.
- Item 10: Financing – Within Item 10 the franchisor must disclose whether or not the franchisor offers franchisees financing as to initial fees to be paid by the franchisor or in connection with the franchised business.
- Item 11: Assistance, Advertising, Computer Systems, and Training – Within Item 11 the franchisor must disclose the type of assistance and training that the franchisor will provide to the franchisee, advertising requirements imposed on the franchisee, and the required computer and software systems that the franchisee will be required to purchase and utilize.
- Item 12: Territory – Within Item 12 the franchisor must disclose if the franchisee will be awarded a protected territory, whether or not the territory is protected, how the territory will be determined, and instances where the franchisor reserves the right to operate within the franchisees territory.
- Item 13: Trademarks – Within Item 13 the franchisor must disclose information about the trademarks of the franchise system, including, whether or not they are registered with the United States Patent and Trademark Office, their registration status, and whether or not the franchisor has notice of a trademark conflict or dispute.
- Item 14: Patents, Copyrights, and Proprietary Information – Within Item 14 the franchisor must disclose information about any patents, copyrights and other proprietary information that is related to the franchise system.
- Item 15: Obligation to Participate in the Actual Operation of the Franchise Business – Within Item 15 the franchisor must disclose what obligations, if any, the the individual franchisees / franchisee owners must have in the day-to-day operations of the franchised business including whether or not they must work in the franchised business on a full time basis.
- Item 16: Restrictions on What the Franchisee May Sell – Within Item 16 the franchisor must disclose its control over what a franchisee may or may not sell as a part of the franchised business.
- Item 17: Renewal, Termination, Transfer, and Dispute Resolution – Within Item 17 the franchisor must disclose and summarize the legal rights and obligations related to the renewal, termination, and transfer of the franchised business. This item must also include a summary as to how legal disputes must be resolved between the franchisor and franchisee.
- Item 18: Public Figures – Within Item 18 the franchisor must disclose if there are any celebrities or other public figures that have been hired to promote the franchise system.
- Item 19: Financial Performance Representations – Within Item 19 the franchisor must disclose whether or not it is making any Financial Performance Representations and if it does, the franchisor must provide specific detail within Item 19.
- Item 20: Outlets and Franchisee Information – Within Item 20 the franchisor must disclose, in five separate tables, a summary of the franchised and corporate outlets over the prior three years and a projection as to future opening in the next year.
- Item 21: Financial Statements – Within Item 21 the franchisor must disclose and include copies of the Franchisor’s Financial Statements.
- Item 22: Contracts – Within Item 22 the franchisor must list and attach as an exhibit all contracts that a franchisee must sign with the franchisor. These contracts include a sample of the franchisor’s standard franchise agreement and related agreements such as a development agreement, site selection agreement, release agreement, and others.
- Item 23: Receipts – Within Item 23 the Franchisor must include two copies of the receipt page. The receipt page is the page that a franchisee must sign to confirm and prove the proper disclosure and delivery of the FDD.
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 the issuance date of a FDD 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. 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 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.
What States Require a FDD 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.
Does the FDD Disclose Business Information?
Yes, 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 and visit the Learn Franchising section of our website to access our FREE webinars and guides about franchising and growing your franchise.
To Learn More About how we can help Franchise Your Business, Register your FDD, and Grow your Franchise, contact us at (718) 979-8688 or fill out our contact form.
Download PDF – Everything You Need to Know About the FDD.