The Franchise Disclosure Document
Franchise Disclosure Documents serve as the legal and business underpinnings for a franchise system. The Franchise Disclosure Document (also referred to as a FDD) is a document that contains legally mandated disclosures and information about a franchise offering that a franchisor must provide to a franchisee prior to offering and selling a franchise. There are many elements and aspects to a FDD and your perspective will and should be significantly influenced on whether you are a franchisor looking to sell a franchise or you are a prospective franchisee evaluating whether or not to buy a franchise.
This article addresses and evaluates what an FDD is from the standpoint of a franchisor. If you are a franchisee or you are considering the purchase of a franchise and you would like to learn more about how to utilize the FDD in your franchise review and due diligence, click here.
The FDD as a Legal and Regulatory Document
The Franchise Disclosure Document is a legal document mandated by federal and state franchise laws and regulation. At the federal level the Federal Trade Commission regulates franchising and at the state level various states have enacted state franchise laws and certain states (know as the franchise registration states) have enacted laws requiring franchisors to register and file their FDD with state governments. As a legal and regulatory document, consider the following facts:
- A Franchisor's FDD contains legally mandated disclosures that are broken down into twenty-three disclosure "Items".
- Prior to offering or selling a franchise anywhere in the United States a franchisor must timely disclose and deliver (typically (14 days prior to receiving any funds or signing any agreement) the FDD to a prospective franchisee.
- The FDD must meet the disclosure requirements of the federal government (the FTC) and the states that have enacted specific state regulations.
- If a prospective franchisee is located within a franchise registration state, then the FDD must be registered with the state prior to offering or selling franchises.
- The FDD must contain audited financial statements of the franchisor (although there is a partial financial statement phase-in exemption for new franchisors) and it must include the franchise agreement and other legal documents that will form the relationship between franchisor and franchisee.
- The twenty-three FDD disclosure Items include information about the franchised business, information about the franchisor, the history of the franchisor and the franchisor's management team and all legal and business aspects of the franchise that is being offered. All twenty-three items are listed below.
- You FDD must remain updated and registered. A technical defect in your FDD or a failure to maintain a current, updated and, where applicable, registered FDD can destabilize a franchise system and subject you to franchisee liability.
The FDD as a Business Document and Blueprint for Your Franchise System
Although the FDD is derived from legal requirements and mandated disclosure items, the FDD is also an important business document and it is very much a blueprint to your franchise offering. Your prospective franchisees will be comparing your FDD to competing franchise systems and will be evaluating how your franchise system stacks up in terms of legal requirements and the unit economics and fees associated with your franchise system. As a legal and business document and blueprint, consider the following facts:
- Within the FDD you will be disclosing the type of franchise that you are offering, the initial franchise fee that you charge and the on-going royalties that franchisees will be required to pay to you. So 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.
- If prepared correctly, the development of your FDD is extremely flexible and must be customized to your business and your franchise growth plan. For example, consider some of these questions regarding your FDD:
- What Franchise Structure Have You Adopted. 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 Opportunity Types. 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 that he or she established, i.e., a full service type location or, alternatively and more limited service express type operating unit?
- What is 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 maybe a fixed fee royalty or possibly even a no royalty structure.
- Do You Offer a Protected Territory. Are franchisees granted a protected territory or are there no restrictions on your right as the franchisor as to where you may locate or grant competing franchises?
There are many other variations and many other questions that need to go into the FDD development process but the point here is that your FDD needs to reflect your system and a plan to strategically grow your franchise system.
The 23 Disclosure Items
The twenty-three disclosure items that must be included in a FDD are:
- 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: Franchisor's 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