Are you considering franchising your business? Learn about the five franchise documents needed to franchise a business.
Franchising is a legal and business relationship regulated by federal and state franchise laws and subject to contractual legal rights between franchisor and franchisee. The primary franchising documents needed to create a franchise relationship and franchise your business include:
- Franchise disclosure document
- Franchise agreement
- Operations manual
- Franchise Registration Applications and Notices
- Financial Statements
1. Franchise Disclosure Document
Before you can offer or sell a franchise you are required to issue and disclose a franchise disclosure document (FDD) to the individuals that you are offering your franchise to and who may eventually sign a franchise agreement and become your franchisee.
“When franchising a business and working with a franchise lawyer, (franchisors) should expect that their franchise lawyer not only knows how to implement an FDD that complies with the franchise laws, but that their franchise lawyer possesses a deeper understanding of the franchise sales process and best practices. A good FDD needs to provide legal protection while also competitively positioning the franchise offering and providing their franchisor clients with the best opportunity to succeed,” says Charles N. Internicola, founder of the Internicola Law Firm, P.C. with over 25 years of experience with franchise law.
The FDD is a legal document that includes 23 disclosure items that require the disclosure of specific information about you, your franchise offering, and the legal obligations between you and your franchisees. As a legal document, the FDD must comply with the federal and state franchise laws and should be prepared by a franchise lawyer.
As mandated by the Federal Trade Commission (FTC)’s Franchise Rule, franchisors are legally required to disclose the FDD to a prospective franchisee no later than 14 days before signing a franchise agreement or accepting fees related to the sale of the franchise. It’s important to note that some states have enacted additional laws regarding the issuance of the FDD, so the FDD disclosure period may vary depending on the franchise location.
The purpose of the FDD is to provide prospective franchisees with enough information about the franchise offering to accurately weigh its benefits and potential risks before making a purchase.
“If you franchise the right way, an experienced franchise lawyer should have no problem obtaining FDD registration in the franchise registration states. After franchising a business, whether or not you register in a franchise registration state should be based on a growth strategy and not whether or not a state requires registration,” Internicola says.
2. Franchise Agreement
The franchise agreement is the legal agreement that creates a franchise relationship between franchisor and franchisee. Within the franchise agreement franchisors grant to franchisees the legal right to establish and open a franchised business. Primary rights and obligations contained in a franchise agreement, include:
- Right to Develop and Operate the Franchised Business - Within the franchise agreement franchisees are granted the legal right and license to use the franchisors trademarks, duplicate the franchisor's business model, and to operate the franchised business.
- Territory Rights - Franchisees are granted territory rights allowing the franchisee to operate the franchised business and, in many instances, to operate exclusively within a territory.
- Compliance with Franchisor's Standards and Specifications - Franchisees are required to comply with franchisors standards, specifications, and requirements related to the development and operation of the franchised business.
- On-Going Fees and Support - On-going franchisees are required to pay royalties and other fees to the franchisor and the franchisor is required to provide the franchisee with support and, overall, to maintain and improve the franchise system.
3. Operations Manual
The franchise operations manual is a confidential manual provided to franchisees to inform and advise them about the franchisors system standards and requirements related to the development and operation of the franchised business.
“Developing a good franchise operations manual is critical to the long-term success of a franchise system,” Internicola says. “The operations manual is a necessary tool for training, supporting, and informing franchisees about systems standards. The operations manual also helps to form a bridge between the legal obligations contained in the franchise agreement and how these legal obligations are implemented in the operations of the franchised business.”
As a franchisor, the operations manual is a confidential document that you will provide to your franchisee after he or she signs a franchise agreement. The operations manual will serve as the how-to guide for your franchisees and should cover everything from your initial training program through the standards and requirements for the development and day to day operations of the franchised business.
Although your full operations manual is a confidential document that should only be provided to franchisees after a franchise agreement has been signed, it’s important to note that the manual’s table of contents must be included in your FDD. This pre-disclosure gives prospective franchisees the opportunity to evaluate their legal obligations prior to entering into a franchise agreement.
Operations manuals are intended to evolve and be supplemented over time as your system standards evolve and change over time. In the past operations manuals typically took the form of printed manuals but today they are evolving into digital cloud based documents that are interactive and include videos.
4. Franchise Registration Applications and Notices
As part of the franchising process, franchise registration applications must be filed within the franchise registration states. Additionally, in states known as the known as franchise filing states, franchisors must also prepare and file applications and notices advising and informing as to the potential sale of franchises within the state.
"Generally, franchise filing and notice states are states that don’t necessarily have franchise laws but have business opportunity laws,” Internicola explains. “In these states, when you file or notify the state about your franchise offering, what you are doing is obtaining an exemption from local business opportunity laws because you are a franchise. The filing process is typically fast and inexpensive.”
Visit our interactive franchise registration map to learn more about the franchise registration and franchise filing states including state specific requirements.
5. Financial Statements
The final documents needed to start a franchise are financial statements. By law, franchisors are required to include specific financial information within their FDD in order to provide prospective franchisees an opportunity to evaluate the company’s financial track record – and any potential financial risks – prior to making an investment.
“There are two levels of financial statements that are important to franchisors,” Internicola explains. “These financial statements include the audited financial statements that franchisors must include in their FDD and the internal financial statements that track the performance of company owned outlets and franchised outlets and are used to prepare Item 19 financial performance representations.”
For established franchises, the general rule is to include the company’s last three years of audited financial statements when issuing the FDD. For new franchises, however, the rules typically change a bit due to the lack of historical financial data.
Because new franchisors will likely be setting up a new corporate entity in order to sell franchise opportunities, the new company will have no previous financial activity. If you are new to franchising and your franchise company is new then the financial statements will be limited to an opening balance sheet for your new franchise company. However, over time these financial statements must evolve into fully audited financial statements that include Statement of Operations, Balance Sheet, and Statement of Cash Flows.
Getting Started – Franchise the Right Way
To learn more about franchising your business, the documents involved and how we can help, contact us at (718) 979-8688, live chat, or click here.