Franchise Sales Compliance Guide

Review the FDD Before You Disclose It

Franchise compliance begins with issuance of an FDD.

Your FDD is issued when it is prepared in compliance with federal and state franchise laws and you, as franchisor, elect to use it in the offer or sale of a franchise. The issuance date is the date you and your franchise counsel determine the FDD to be current and compliant. It must appear at the bottom of the cover page and on the receipt page. At the federal level, you are not required to register or file your FDD with any agency.

Your FDD must be accurate and current, without material omissions or misrepresentations. It must contain the 23 Disclosure Items required under the Federal Franchise Rule, plus any state-specific modifications for the states where you offer or sell franchises.

Review the FDD Before You Disclose It

Before your FDD is used with a single prospective franchisee, whether newly issued or renewed, review it as if you are seeing it for the first time. The FDD was prepared from information you provided, so confirm that every disclosure still reflects your system today:

• Item 1, Franchisor and Affiliates. All companies sharing common ownership with you or your franchise company are disclosed.
• Item 2, Business Experience. Everyone who plays a material role in sales, training, support, or operations is disclosed. Job title is not determinative. Keep an internal "Item 2 Roster" and update it when personnel change.
• Items 3 and 4, Litigation and Bankruptcy. These cover lawsuits, arbitrations, regulatory actions, consent orders, and assurances of discontinuance. They apply to the franchisor, its affiliates, and each Item 2 individual, including matters from prior employers. Collect written certifications from Item 2 individuals, and notify counsel as soon as a new matter arises.
• Item 6, Other Fees. Every fee actually charged is disclosed and matches the franchise agreement.
• Item 7, Estimated Initial Investment. Estimates are current and supportable, including the three-month "Additional Funds" estimate. Understating Item 7 is one of the most frequent claims in franchise litigation. When in doubt, disclose a higher or broader range.
• Item 13, Trademarks. You are not aware of any infringement, challenges, or claims of superior rights.
• Item 19, Financial Performance Representations. The data is accurate, supported, and representative (see the Item 19 section below).

If anything is inaccurate, outdated, or incomplete, stop and contact franchise counsel before disclosing.

State Addenda and Franchise Agreement Riders

Registration and filing states often require state-specific FDD addenda and franchise agreement riders. These address issues such as venue and governing law, non-competes, general releases, termination and renewal rights, supplemental litigation disclosures, and Item 19 requirements. They are legally required, not optional.

Selling without the applicable addendum and rider leaves the FDD materially incomplete for that transaction. The result can be regulatory action, rescission rights for the franchisee, and personal liability for principals. Before any transaction in a registration or filing state, everyone on the sales team should read the applicable addendum and rider. Also confirm that the rider is included in the executed franchise agreement.

TIP: Separate from franchise registration, review your sales activity in each state with your accountant or corporate attorney. You may need authorization to do business in that state or have tax filing obligations there.

Franchise Agreement Preparation and Disclosure

Once the FDD has been properly disclosed and the receipt signed, the next step is preparing the franchise agreement and properly disclosing the completed agreement. We recommend the following steps, reviewed and handled by your franchise lawyer:

1. Collect franchisee information. Use a standard form to confirm:

• whether the franchisee is an entity or an individual;
• entity details and ownership;
• individual legal names and addresses; and
• whether the franchisee has legal counsel.

2. Confirm registrations and filings. Confirm that all required state registrations and filings are current.

3. Prepare the franchise agreement. Include accurate franchisee information, signature lines, territory or location, and personal guarantees where applicable.

4. Attach state addenda. Attach any required state-specific addendum.

5. Document negotiated changes by addendum. Never edit the form agreement itself, and review every negotiated change with counsel.

6. Disclose completed agreements and wait 7 days where required. In some cases, changes initiated by and benefiting the franchisee may not trigger the waiting period. Review this case by case with counsel.

7. Sign and collect fees. Once waiting periods are satisfied, have the franchisee sign and pay, then countersign and provide a copy.

8. Build a compliance file. Keep:

• the signed receipt page;
• proof of agreement disclosure;
• the executed agreement and addendums;
• the franchise sellers and brokers involved;
• approved concessions; and
• material communications.

Disputes can arise years later, so your records should show what was sent, when, and by whom.

CAUTION: Some states impose financial assurance requirements, including California, Hawaii, Illinois, Maryland, Minnesota, North Dakota, Virginia, and Washington. If your sale involves one of these states, determine whether the state has imposed a financial assurance requirement on your system before accepting any funds or initial fees. This often means deferring initial fees. Emerging franchisors are especially likely to have this condition attached to their registration.

CAUTION: In California, negotiated changes to the franchise agreement may require state approval or filing. Discuss this with your attorney.

FDD Updates and Renewals

Your FDD must be updated at least annually, and sooner when material changes occur. When you update your FDD, you must also amend your registrations in the registration states.

• Annual updates. Your FDD must be updated within 120 days of fiscal year-end, which is April 30th for calendar-year franchisors. Once it expires, you must stop selling. You must also renew state registrations and applicable filings. Learn more about FDD Expiration and Renewals.
• Quarterly updates. Any material change must be reflected in the FDD and state registrations within the following quarter. A change is material if it would influence a reasonable prospective franchisee's decision.
• Immediate updates. Changes to Item 19, or a discovered material omission or misrepresentation, require an immediate update.

State registration dates don't always align with the federal 120-day rule. For example, a Virginia registration effective in October may run another year, but a calendar-year franchisor's FDD still expires April 30th, and sales must stop then. File renewals before the federal deadline and, where possible, align state effective dates with your renewal cycle.

Your sales, finance, operations, and legal teams should have a clear process for flagging changes that may affect the FDD. These include personnel changes, new litigation, new fees, rising buildout costs, supplier or rebate changes, and changes in Item 19 data.

TIP: Submit renewals well in advance. States can take one to two months to process them, and a late filing means your sales "go dark" in that state.

Franchise Sales Rules: Stay Within Item 19 and the FDD

A compliant Item 19 only protects the franchisor, and everyone selling on its behalf, if it is used correctly. The rules below apply equally to franchisors, their employees, and outside brokers and sales agents. When this section refers to "your team," it includes you if you sell franchises for a franchisor.

Present Item 19 as a Complete Disclosure

Having an Item 19 does not give anyone permission to discuss financial performance generally. Item 19 sets the boundaries of what the franchisor has elected to disclose.

Every number in Item 19 is defined. Each figure is tied to defined terms, a specific outlet population, a methodology, a reporting period, exclusions, and footnotes, and those elements are part of the disclosure. Extracting a figure and presenting it on its own is not compliant, because, when a figure (number) is isolated, the figure no longer means what the disclosure says it means.

Do not reduce Item 19 to headline numbers such as "average sales are $1.2 million" or "gross profit is 42%." Direct candidates to the complete Item 19, and explain that the numbers must be read together with their definitions and context.

Do Not Turn Item 19 Into a Calculator

Item 19 is not a library of assumptions that can be extracted and recombined into new projections. For example:

Candidate: "Let's assume I do $900,000 in sales."
Salesperson: "Item 19 shows Gross Profit of 42%, so that's about $378,000."

The 42% was disclosed as a historical result for a defined population, not as a universal assumption for any candidate's projected sales. Once the salesperson completes the equation, they have created a new, candidate-specific projection that does not appear in Item 19. That is true even when the candidate supplies the first number.

The same applies to using any of these Item 19 figures as building blocks for a projection:

• average revenue;
• labor or COGS percentages;
• customer counts;
• average ticket;
• job or event counts; or
• EBITDA.

Discovery Day and Confirmation Calls Follow the Same Rules

Candidates often feel more comfortable asking financial questions at Discovery Days, confirmation calls, and founder meetings, and executives naturally want to explain how the business works. The informality does not change the rules. No one should use these settings to provide earnings information, projections, or assumptions beyond Item 19. What is said in the room matters as much in later litigation as what is written in an email.

Franchisee Validation: Don't Steer, Script, or Compensate

Talking to existing franchisees is one of the most valuable parts of a candidate's due diligence. How the franchisor and its sales team handle validation matters.

Item 20 of the FDD lists current franchisees and those who left the system in the last fiscal year. Candidates should be encouraged to contact as many of them as they want. Problems arise when the franchisor or its sales team controls the process:

• Selective referrals. Steering candidates only to top performers or hand-picked "validators" can create a misleading impression of typical results. It is the same cherry-picking problem Item 19 prohibits. If you suggest specific franchisees, always point candidates to the complete Item 20 list as well.
• Franchisee financial statements. A franchisee independently describing their own experience is different from a franchisee the franchisor or its salespeople selected, prepared, or coached. When the franchisor is involved, statements a validator makes about earnings can be attributed to the franchisor as an unauthorized FPR.
• Compensation. Paying franchisees for validation calls or referrals can make them franchise sellers who may need to be identified in the sales process. Avoid it, or review it with counsel first.
• Scripting and participation. Do not script validation calls, coach franchisees on what to say about financial performance, participate in the calls, or discourage candidates from contacting former or unhappy franchisees.

Our Advice on Pro Formas: Don't Provide Them

No pro formas. No candidate financial modeling. No coaching of assumptions.

That applies even when the worksheet is blank and even when it states that the candidate supplies every assumption. No matter how careful the pro forma or how strong the disclaimers, franchisee attorneys will claim it was a vehicle for unlawful FPRs. They will argue the franchisor or its salesperson coached the candidate on the assumptions, since a buyer who has never operated the business has no basis to estimate sales, customer counts, labor, or margins without guidance.

The worksheet then becomes tangible evidence for that allegation. The dispute turns on questions such as who suggested the revenue number and who walked the candidate through the spreadsheet. The franchisor may ultimately prove it gave no information beyond Item 19, but by then it, and potentially the salesperson, is already in litigation.

Compare that with a franchisor that takes a hard-line position: the only financial information we provide is what appears in Item 19.

There is a business reason as well. When a franchisor helps build the candidate's model, the franchisee may come to believe the franchisor is responsible for their financial outcome.

No one involved in the sale should:

• suggest revenue, profit, EBITDA, or margin assumptions;
• recommend labor, COGS, occupancy, marketing, staffing, or other operating assumptions;
• estimate customers, transactions, jobs, or events;
• calculate ROI, payback, cash-on-cash return, or break-even;
• build "conservative," "expected," or "aggressive" scenarios;
• tell a candidate an assumption is realistic, too high, too low, or in line with other franchisees; or
• use Item 19 figures as building blocks for projections.

Candidates should do their own financial analysis using the FDD, Item 19, Item 7, independent validation, and their own accountant, attorney, or lender. The role of the franchisor and its sales team is to accurately disclose the opportunity, not to be the candidate's financial planner.

Avoid Oral Promises and Statements Outside the FDD

Franchise disputes frequently involve allegations that something was promised but never appeared in the FDD or franchise agreement. Avoid statements such as:

• "No one else will ever be near you."
• "We'll give you all the leads you need."
• "Your costs will never be more than this."

If an answer cannot be supported by the FDD or an approved sales resource, do not improvise. Escalate the question.

Review Your Advertising and Marketing

FPRs can be made through websites, social media, videos, webinars, broker materials, and email sequences, not just sales calls. Make sure marketing, franchise development, and outside brokers all work from the same approved information.

Train Your Sales Team and Document It

Before selling franchises, the franchisor should conduct documented training with every member of the sales team, including outside brokers and sales agents. Each person should sign an acknowledgment that they understand the FPR restrictions. Repeat the training annually and whenever someone new joins the sales process.

Training should cover:

• how to present Item 19 in context;
• the no-calculator and no-pro-forma rules;
• validation practices;
• how to respond to projection requests;
• what may be said about suppliers and fees;
• who approves negotiated terms; and
• when to escalate.

Brokers and sales agents should treat the acknowledgment as a personal commitment. Signing it confirms that you understand these rules apply to you individually.

The rule to remember: Item 19 is the disclosure, not the starting point for a broader financial discussion. When unsure, stop and get guidance. A short pause in the sales process costs far less than explaining years later what someone meant on a sales call.

Learn more about Financial Performance Representations, what they are, and what you must avoid.