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.
As most experienced franchisees know, opening a franchised business isn’t an inexpensive venture – especially when you’re just getting started.
In addition to having enough capital to cover startup expenses like initial fees, equipment, inventory, and more, it’s recommended that new franchisees have enough reserve capital to cover their cost of living during their first several months of operations. Because of that, franchisee candidates should make sure they’re properly capitalized and aware of the funding options available to them before buying a franchise.
Within Item 10 of the Franchise Disclosure Document (FDD), franchisee candidates can learn about financing arrangements that might be available to them as franchisees. Although not all franchisors offer financial assistance to franchisees, some offer financing programs – a perk that can come with advantages and disadvantages for the franchisee. Because of that, prospective franchisees should make sure they fully understand the terms and conditions of any financing arrangements that will be available to them before making an investment decision.
In this article, we’ll explore the information that franchisors must legally disclose in Item 10 to give franchisee candidates a clear picture of the financing options that will be available to them as franchisees.
What Information Must Be Included in Item 10?
Because the purpose of Item 10 is to help prospective franchisees understand the terms of any financing options available to them during the process of buying and operating the franchised business, franchisors must disclose the material terms and conditions of every financing arrangement the franchisor, its agents and/or affiliates offer to franchisees. Item 10 disclosures should include leases and installment contracts, as well as direct and indirect financing offers.
For the purposes of this disclosure item, the Federal Trade Commission defines indirect financing as offers of financing that “include a written arrangement between a franchisor or its affiliate and a lender, for the lender to offer financing to a franchisee; an arrangement in which a franchisor or its affiliate receives a benefit from a lender in exchange for financing a franchise purchase; and a franchisor's guarantee of a note, lease, or other obligation of the franchisee.”
Material Terms of Financing Arrangements
Per the requirements of the federal Franchise Rule, franchisors must provide the following information for each financing arrangement disclosed in Item 10:
The item covered by the financing arrangement (the initial franchise fee, inventory or supplies, etc.).
The lender’s identity and their relationship to the franchisor.
The amount of financing offered to the franchisee. (In situations where the financing amount is determined by actual costs that may vary, franchisors may provide the percentage of the cost to be financed.)
The annual interest rate plus finance charges. (If this amount is dependent on the date of issuance, franchisors must state the rate on a specific recent date.)
The number of required payments, or the period of repayment.
Security interest that is required by the franchisor, if any.
Whether anyone besides the franchisee must guarantee the debt personally.
Whether the debt can be prepaid and the terms of any prepayment penalties.
The franchisee’s possible liabilities in the event of default, including any accelerated obligations to pay the full amount, court costs or attorney’s fees related to debt collection, franchise termination and cross default liabilities.
Any other material financing terms imposed on the franchisee that haven’t already been disclosed.
For disclosures that require additional information, franchisors may include corresponding footnotes.
Waiver of Defense or Legal Rights
In Item 10, franchisors must disclose whether the loan agreement requires franchisees to waive their defenses or legal rights, including the ability to assert a defense against the franchisor, the lender or the lender’s assignee. If an agreement does require such a waiver, the franchisor must disclose those terms.
Intent to Sell, Assign or Discount
Franchisors must also disclose whether their intent or practice is to sell, assign or discount some or all of the financing arrangement to a third party. If so, the franchisor must disclose the terms of those assignments, including whether the franchisor will remain primarily obligated to provide the goods or services being financed. In situations where some of all of the financing arrangements are sold, assigned or discounted to third parties, the franchisor must also state that the franchisee could lose all of its defenses against the lender because of the assignment or sale.
Consideration Received by Franchisor
Within Item 10, franchisors must disclose whether the franchisor or its affiliates receive consideration for placing financing agreements with a lender. In situations where a franchisor or its affiliates does receive consideration for financing placements, the franchisor must disclose either the amount of the payment or the method for determining the amount of the payment, as well as the source of the consideration and the source’s relationship to the franchisor or its affiliates.
Although it is recommended that financing disclosures be presented in tabular format in Item 10 of the FDD, 16 CFR § 436.5(j) does not establish any specific formatting requirements. However, it is standard industry practice to present Item 10 disclosures in a table format for organization and clarity.
Although Item 10 is a relatively straightforward disclosure item, there are several nuances that franchisors and franchisees should keep in mind when preparing or reviewing the FDD.
According to the federal Franchise Rule, franchisors may elect to disclose installment payment terms in either Item 5 or Item 10.
It’s important to remember that sample copies of the financing agreements available to franchisees must be included in Item 22. When developing the FDD, it can be a good idea to compare the disclosures in Item 10 with those in Item 22 to verify that no financing arrangements have been overlooked.
Franchisors and franchisees should be aware that the disclosure of financing arrangement terms in Item 10 of the FDD does not prevent both parties from negotiating alternative financing terms before signing the franchise agreement. Because negotiations in financing arrangements can have legal consequences, it’s best to consult with an experienced franchise attorney about any changes to terms and conditions summarized in Item 10.
Material Changes by Franchisor
If a franchisor changes any terms or conditions in Item 10 independently after disclosing the FDD to the franchisee candidate, the prospective franchisee will have seven calendar days to review and accept or reject the changes due to the material nature of the revision.
In situations where a franchisor and its agents and/or affiliates don’t offer financing options to franchisees, franchisors must only provide a negative disclosure within Item 10. Although there are no requirements set forth by the FTC regarding the specific language that must be used under these circumstances, it’s recommended that franchisors specifically state that no direct or indirect financing options are available to franchisees. An experienced franchise attorney can help non-financing franchisors determine the best negative disclosure language based on the unique needs of the business.