Franchise Articles

Posted on Jan 04, 2011

Items 11-23 of the FDD and how they can help you

Items of the FDD and how they can help you (Item No.11-23)

In part 1 we discussed the initial 10 items listed in the FDD. They mostly pertained to the operations and general information of the franchisor, however the remaining items delve slightly deeper into the legalities of the operations and the existence of the franchisor-franchisee relationship. It is best to have legal consultancy when investigating these items and realizing the viability of the franchise as a potential investment in the future.

The remaining items stated on the FDD are listed as:

Item No.11: Obligations of Franchisor: Other Supervision, Assistance or Services:

The franchisor often offers certain services and assistances to the franchisee. This item discusses the initial and on-going obligations of the franchisor. These items are identified in two separate categories which are:
a)      Service obligations of the franchisor
b)      Services that may be performed by the franchisor
Some of these services include training, providing advertizing material, site selection, market research and computer services. Other services may also be listed here.

Before signing any agreement it is best for the prospective franchisee to know what to expect from the franchisor in return. This helps them realize their domain of operations and also helps them designate capital on other operations instead which do not fall into the franchisor’s domain.

Item No.12: Territorial Rights:

Franchisors often provide exclusive rights to their franchisees in certain territorial areas which must be stated here. In this item the franchisor grants exclusive rights, the territory and the respective rights will be discussed in this section. Any conditions which the franchisee must meet to retain these rights, such as certain sales levels, must be disclosed alongside the rights of the franchisor as well.

Franchisees need to have the security that they would be the only exclusive patron of the certain franchise. It would be amiss if after spending capital on gaining the rights of a franchise, another franchisee opens the same franchise in a certain geographical location. Therefore this clause allows franchisee’s to know their rights and also act according to the rights of the franchisor.

Item No.13: Trademarks, Service marks, Trade names, Logo Types and Commercial Symbols:

The franchisor must provide information detailing the registration of trademarks, service marks, trade names, logo types and commercial symbols with the U.S. Patent and Trademark Office. Also to be included are the list of states and countries in which the marks are registered, as well as any limitations imposed on the franchisee for the use of these marks.

The franchisee does not own the trademarks and trade symbols so they must realize the legal permissibility of using certain logos, names and marks for their regular business operations without crossing any copyright infringements.

Item No.14: Patents and Copyrights

This disclosure lists any patents and copyrights that may be involved in the operation of the franchise and that may cover trade secrets and confidential information.

Certain franchises have been built on certain formulae for their food or operations. These are usually copyrighted and are trade secrets. The patents secure the franchisor from the fear that the franchisee steals their secrets and use them to compete with the franchisor in the future. The patents and copyrights are disclosed here so that the franchisee can know which items are to be maintained secrets at all costs.

Item No.15: Obligation of the franchisee to participate in the operation of the franchise business:

This item identifies whether the franchisor requires the active participation of the franchisee in the operation of the business. This may not always be necessary for every franchise, but for certain franchises which do require so, this item states that fact.

This item on the FDD informs the prospective franchisee whether they would be required to be actively involved rather than simply act under a management role. This stipulation is important for those franchisees which are looking to simply make an investment and have others be responsible for the duties. Franchisees must recognize whether their services would be required in the basic running of the business.

Item No.16: Restrictions on goods and services offered by franchisee:

Any limitations or exclusions on goods and services that can be commercialized by the franchisee are clearly stated in this item of the FDD.

This is a clear statement of which goods and services the franchisee may not offer. This may be due to the reputation of the brand or company policy in general.

Item No.17: Renewal, Termination, Repurchase, Modification and Assignment of the franchise agreement and related information:

Possibly the longest and most complex item in the entire FDD, this item covers the franchisor’s requirements and the franchisee’s options when a franchise is to be renewed, terminated, repurchased, modified or assigned and under what conditions would any of the actions be undertaken.

This section requires the most scrutiny and it is most suggested that the franchisee has a legal consultant assist them in understanding this portion so that they may not later be sprung by anything unexpected if the franchisor declines the renewal of the lease of the franchise or terminates their franchise. The most time should be spent in understanding these stipulations in the FDD and realizing how they may affect the franchisee at some later stage.

Item No.18: Arrangements with Public Figures:

If the franchisor has any brand representatives or compensation or endorsement program with a public figure, it must be disclosed in this item. If the public figure has a personal stake in the form of ownership or management of the franchise, that must also be disclosed within the item.

It is best to know what endorsements or associations are related with the franchise. Sometimes these public figures may be popular in certain geographies whereas in others they may illicit not so positive emotions. Therefore a franchise which is owned by a certain popular baseballer, may be popular in one city while in another that same figure may be unfavorable. Franchisees must know who are endorsing the brand before going into any agreement.

Item No.19: Actual, Average, Projected or Forecasted Franchise sales, profits or earnings:

This item offers some options to the franchisee. The franchisor may state that they do not furnish the actual, average, projected or forecasted sales and earnings to their prospective franchisees. If the franchisor does make a claim of having set sales, profits or earnings figures then the franchisor must also fully disclose the method by which the claim has been made.

If the franchisor offers high goals while does not have any proven method or strategy for attaining the goals, then the franchisee can be forewarned through this item in the FDD. Similarly, the set expectations may be too high for a franchise in certain areas. The franchisee can then avoid going into an agreement with the franchise and choose someone with more realistic potential in their locality.

Item No. 20: Information Regarding Franchises of the Franchisor:

The franchisor must provide a summary of franchises sold, the number of franchises currently operating, the number of agreements signed so far but not in operation, and the number of company owned units. Information on the number of franchises terminated or not renewed with the actual causes for termination or non-renewal for the past 3 years are also required to be mentioned in this item.

The item plays an important role in understanding the expansion plans of the franchise and to understand the past record of the franchisor in dealing with franchisees. Evaluating the reasons behind the non-renewals of other franchise may provide tips with how to deal with the franchisor while the number of franchises operating would justify the cost of investment into the franchise. Investing in a franchise such as McDonald’s would probably cost more than a franchise with little exposure.

Item No.21: Financial Statements:

This section contains the complete set of financial statements, which usually includes the balance sheet for the past fiscal year, an income statement and changes in the financial position of the franchisor for the most recent 3 fiscal years. Most states require these statements to be audited.

Naturally the financial position of the company would be included in the FDD, and this item offers the hard facts pertaining to the operation of the franchise. The financial statements and other documents provide the strength of the company at a point in time with their total assets and other monetary variables describing the company’s position.

Item No.22: Franchise Agreement and Related Documents:

A copy of the franchise document and any other document to be signed by the franchisee must be included as exhibits.

A legal consultant specialized in franchise agreements should be included to analyze the documents so that they do not have any harmful stipulations for the franchisee. This would also give the consultant arguments and points to include in the agreement at the negotiating stage of the franchisor-franchisee agreement. Since negotiation is perfectly legal, this document gives the franchisor’s point of view and the franchisee can introduce their own suggestions for the agreement using these documents as samples.

Item No.23: Acknowledgement of receipt by a prospective franchisee:

Prospective franchisees must sign an acknowledgement that a disclosure document was received from the franchisor so that the franchisor may initiate the franchising agreement otherwise they will not since the FTC would legally not permit them to carry forward with expanding their franchise network.

This is the final acknowledgement and is simply there for the benefit of the franchisor to report that they fulfilled their obligation of divulging their information to the prospective franchisee  and having given the franchisee with all the necessary information to make an informed decision.

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