One big advantage that occurs within the potential franchisee’s due diligence timeframe is that the franchisor is required by law to provide what is called a Franchise Disclosure Document (FDD) during the pre-sales disclosure process. (Note: This used to be called a Uniform Franchise Offering Circular.)
This document is required to be submitted to potential franchisees by the Federal Trade Commission (FTC) Franchise Rule. This rule gets into the specifics of FDD disclosure obligations including when (at least 14 days prior to any contract signing) the franchisor has to provide the document.
The FDD contains the following valuable information:
- Franchisor information like how long they have been in business and likely competition
- Key person business experience
- Any litigation history that has occurred with the franchisor
- Any information on if the franchisor ever filed for bankruptcy
- The franchise fee and other fees and expenses the franchisee will have to pay such as advertising costs, monthly royalties and training expenses
- The training and assistance program used by the franchisor
- Your estimated initial investment and obligations to the business
- Financing arrangements
- Franchisor obligations
- Territory, trademarks, patents, copyrights and other proprietary information
- Restrictions on any goods or services you can offer
- Renewal, termination, repurchase, modification, transfer of the franchise and the dispute resolution process
- Financial information about the franchisor including financial statements
- A list of franchise outlets
This is not a comprehensive list but it provides the majority of what you will receive with the FDD. The FTC site at http://www.ftc.gov/bcp/franchise/faq1.shtm provides more information on the disclosure obligations of the franchisor.
Consider these powerful facts about franchising:
- There are about 825,000 U.S. franchise business
- 40.9 percent of all retail businesses are franchises
- Franchising contributes 8.2 million direct jobs and 18 million indirect
- Franchising adds $2.1 trillion to annual U.S. Gross National Product [GDP]
That’s the way it stands now but it was a long road getting there. Some of the most popular and well known franchises were created spanning many decades:
- Howard Johnson 1925
- Kentucky Fried Chicken 1930
- Baskin Robbins 1948
- Dunkin Donuts 1950
- Burger King 1954
- McDonald’s 1955
However, the success of these franchisors and others spawned some unfunded and poorly managed franchise ventures in the 1960s and 1970s. Some even bordered on fraud where money was taken from those eager to own businesses but a franchise was not delivered as promised.
The FTC and IFA
The federal government stepped in in the form of the Federal Trade Commission (FTC). Many regulations were added to bring full disclosure of what potential franchisees might be getting themselves into.
In addition, the International Franchise Association (IFA) was founded in 1978. It’s a reputable industry group where franchisor members use the IFA icon to show compliance with best practices and full disclosure. (In 1978, membership was only for Franchisors, today individual franchisees can join.)
Full Disclosure Documents
Also, the FTC created the Uniform Franchise Offering Circular (UFOC). This was updated in 2007 and is now called the Franchise Disclosure Document (FDD).
Along with the FDD, the business contract (Franchise Agreement) must also be included. Every franchise is governed by these two documents. In fact, if it’s not in the Franchise Agreement, it’s not an obligation.
What’s in the Documents?
- A legal description of the business & the term
- Franchisee & franchisor obligations
- All fees & payments
- Detailed Lists of what is included with the fees
- Statement of average unit sales (Item 19, optional)
- Rights to transfer, expand & renew the franchise
- Territorial rights
- Signatures to the contract
- Current & former franchisees list
- Audited statement for the franchisor
- And more…
Obviously, for potential franchisees these are must read documents. They are designed to make sure that everything is above board and the franchisee is getting good value at a fair price and that it’s something that can be verified.