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How to Prepare a Concept for Franchising: Franchise Disclosure Documents

Question:

I have been reading with interest the series in the Michigan Restaurateur on how to prepare a concept for franchising. I understand that I need to develop my brand, systems, operations and unit economics. I understand that I need to duplicate my concept in different markets. I also understand that I need to federally register my trademarks. Are there other legal requirements with which I must comply?

Answer:

Yes. The sale of a franchise is a regulated transaction. Franchise sales are regulated by the Federal Trade Commission and a number of other states across the nation. The FTC’s Franchise Rule and some states’ statutes (including Michigan’s Franchise Investment Law), require pre-sale disclosure to prospective franchisees. These statutes and regulations require a franchisor to disclose all of the risks associated with purchasing a franchise in a standard format, called the Franchise Disclosure Document (FDD).

In the FDD, the franchisor is required to disclose information material to a prospective franchisee’s decision to purchase a franchise in the following topic areas: franchisor’s identity; franchisor’s business experience; litigation; bankruptcy; the amount of initial fees and other fees to be paid to the franchisor; the franchisee’s estimated initial investment; restrictions on the sources of the franchisee’s products and services; the franchisee’s obligations; whether the franchisor offers financing; franchisor’s assistance; the territory of the franchisee; trademarks, patents, copyrights and other proprietary information; franchisee’s obligation to participate in the operation of the franchise; restrictions on what the franchisee may sell; whether the franchisor uses public figures to market the franchise system; a financial performance representation; information about the franchise system and company owned outlets; franchisor’s financial statements; and a list of the contracts that a franchisee must sign. In short, if a franchisee would find the information important in deciding whether to purchase the franchise, the information should be disclosed to the prospect in the FDD.

In addition, the franchisor must provide to prospective franchisees copies of the form agreements that document the relationship between the franchisor and franchisee, including the franchise agreement, area development agreement, master franchise agreement, non-competition agreements, real estate documents, personal guarantees, etc.

The franchisor is required to produce this FDD and all exhibits and deliver it to prospective franchisees no later than 14 days before the franchisor accepts any money from the prospect or signs any agreement with the prospect.

Because much of the information in the FDD relates to actions taken by the franchisor in the previous fiscal year, the FDD must be updated at least annually. Additionally, a franchisor must present to prospective franchisees audited financial statements, meaning that the franchisor’s books must be audited annually.

For a prospective franchisor, the preparation and annual maintenance of the FDD is a necessary investment to ensure that any franchise sales are in compliance with all applicable laws.

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