What can you learn from a Franchise Disclosure Document (FDD)?
History of the FDD
Until the 1960s, there was little franchising momentum in the United States. But after the success of McDonald’s, the franchise industry expanded rapidly. In 1979, the Federal Trade Commission’s Franchise Rule became effective. It required franchisors to provide potential franchisees with a document then referred to as the Uniform Franchise Offering Circular. In 2008, it was renamed the Franchise Disclosure Document or FDD. Its purpose is to enable prospective franchisees to make an educated and informed decision about whether to purchase a franchise.
The amended Rule requires franchisors to furnish the FDD to prospective franchisees at least 14 days before the prospective franchisee signs a binding agreement or makes any payment in connection with the proposed franchise sale. The signing of any agreement or receipt of payment can take place on the 15th day after delivery of the disclosure document. This ensures that prospective franchisees have at least two weeks to review the disclosures.
The FDD’s content
History and Experience. The FDD must include a history of the franchisor’s past activities. This information must address activities of the officers and directors as well as the corporate entity. Examples include business experience and any fairly recent litigation or bankruptcy history.
Financial Factors. The franchisor must disclose the costs involved in purchasing a unit. This includes initial franchise fees, other startup costs, and an estimated range of the total cost of getting into the business. The FDD must specify additional fees such as the royalty, marketing, and renewal fees required throughout franchise ownership.
Obligations and Restrictions. The FDD must set forth the franchisee’s and franchisor’s obligations under the terms of the franchise agreement. It must spell out any restrictions that apply to franchisee behavior.
Other Considerations. The FDD must include relevant information pertaining to a number of other factors such as financing programs, territory, trademarks and patents, renewal or transfer provisions, and public figures.
Exhibits. The company must provide additional materials including audited financial statements, a list of current franchisees and their contact information, contracts, and receipts.
Earnings Claims. The FTC makes it optional for franchisors to supply information about the earning potential of a typical franchise unit. If the franchisor chooses to make earnings claims, it must follow stringent requirements. The data provided must be as accurate and representative as possible. The franchisor must clearly label any assumptions or qualifications.
Individual state requirements
In addition to the federal laws, many states have enacted legislation to further protect franchisees. These laws may mandate additional disclosures or specify rules governing the terms of the franchise agreement.
The following states have franchise registration and disclosure laws that require franchisors to register the franchise before making an offer or sale. A state examiner then reviews the FDD, and in some cases, may designate specific changes or additions that must be made.
- New York
- North Dakota
- Rhode Island
- South Dakota
Hawaii and Wisconsin require that the franchise be registered before a sale. Oregon has a state franchise sales law but does not require registration.
The most important point to remember regarding the FDD is your role: to read and understand the material that the franchisor is providing. The FTC requires this information to be clearly stated. That protection won’t make any difference, however, unless you carefully review the material.