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Franchise Disclosure Document for Dummies – Part 3

In part three of this series on understanding the Franchise Disclosure Document, we continue with Items 8 and 11 (Items 9 and 10, while important, do not lend themselves particularly well to discussion). Item 8 covers suppliers, mandatory purchases and franchisor rebates, while Item 11 covers the franchisor’s pre- and post-opening obligations to its franchisees. Click here to read Part 1 or Part 2.

Item 8 – Restrictions on Sources of Products and Services

In Item 8 of the FDD, franchisors are required to disclose designated and approved suppliers, franchisees’ mandatory purchases, and any rebates they receive from vendors as a result of franchisee purchases.

When a franchisor mandates purchases—whether from itself or a related or independent third-party—prospective franchisees need to perform the appropriate due diligence to ensure that the designated vendor’s prices are in line with industry standards. This is particularly important where the vendor is the franchisor itself, the franchisor’s affiliate, or a vendor who pays rebates to the franchisor as a result of franchisee purchases. Generally, the prospective franchisee will be looking to see that their required purchases are not a significant revenue source for the franchisor.

Important Item 8 disclosures include:

  • Franchisees’ mandatory purchases
  • Identification of designated suppliers
  • Provisions for obtaining approval of alternate suppliers
  • Franchisor ownership of, or affiliation with, designated suppliers
  • Terms of rebates, commissions and other benefits paid to the franchisor by franchisee suppliers
  • Financial disclosures regarding rebates and commissions
  • Whether the franchisor negotiates purchase arrangements for the benefit of franchisees

Each of these disclosures, even if omitted (or, more accurately, made “negatively” [i.e. the franchisor does not negotiate purchase arrangements]), can provide important insight for prospective franchisees when evaluating proposed franchise opportunities.

Item 11 – Franchisor’s Assistance, Advertising, Computer Systems, and Training

Item 11 covers the franchisor’s pre-opening and ongoing support obligations to its franchisees. Item 11 disclosure obligations can be separated into 7 main categories.

Item 11 disclosures include:

  • Pre-Opening Obligations
  • Timeline for Opening for Business
  • Ongoing Support Obligations
  • System-wide and Local Advertising
  • Computer Systems
  • Initial and Ongoing Training
  • Operations Manual

Pre-opening Obligations

The scope of a franchisor’s pre-opening obligations can vary widely depending on the nature of the franchise system. In addition, franchisors required by state regulators to defer or escrow initial franchise fees will often try to limit their pre-opening obligations in order to accelerate their ability to collect. Post-opening and ongoing support obligations will also vary widely from franchisor to franchisor.

System-wide Advertising

With regard to advertising programs, in performing their due diligence, prospective franchisees will want to investigate the efficacy and geographic scope of the franchisor’s advertising efforts. Prospective franchisees will also want to make sure that ad fund contributions are predominantly used for direct ad placement, as opposed to in-house R&D or “administrative” expenses.

The Initial Training Program and Operations Manual

Training and Operations Manual disclosures are similarly critical to the due diligence process. Prospective franchisees should seek to make sure that the initial training program is conducted by qualified individuals, and is sufficiently comprehensive to prepare them to get their franchised businesses off of the ground and running smoothly during the initial phase.

Likewise, whether the franchisor discloses its Operations Manual’s table of contents in the FDD or permits franchisees to review the Operations Manual at its headquarters, prospective franchisees will want to ensure that the Manual is sufficiently comprehensive to meaningfully assist them in successfully operating their business in accordance with the franchisor’s system standards.

Next week, Franchise Disclosure Document for Dummies - Part 4 will discuss Item 12 of the FDD, which covers territory rights of franchisees.

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Jeff Fabian is the owner of Fabian, LLC, a boutique intellectual property and business law firm serving new and established franchisors and prospective franchisees. Contact the firm directly at 410.908.0883 or jeff@fabianlegal.com. You can also follow Jeff on Twitter @jsfabian.

This article is provided for informational purposes only, and does not constitute legal advice. Always consult an attorney before taking any action that may affect your legal rights or liabilities.

The Ideal Franchisee - The Franchisee Point of View

Possessing an entrepreneurial mindset is a plus but one should also have the employee mindset as well. This lies in the fact that even though the franchisee must have the steely determination and drive to launch a business, they must be willing to be restrained and follow the directions of the franchisor. The level of control for a franchisee is noticeably less than of that of being an owner of your own independent business. However the level of risk presented to a franchisee is less than that of an independent business owner. Therefore this type of business is preferable for those looking for less risk. If we were to prepare a checklist of the traits, which were to be present within the ideal franchisee, it would appear something as:

Talking with Current Franchise Owners

Reading through a FDD is a key part of your research, but it can’t answer all the potential questions you might have about how it is to actually operate a given franchise. The best way to do this is actually to start talking to current franchisees. The best way is to this is to call or visit a franchisee, don’t just email them. You might need to be a bit persistent, but if you are then you can get all of your questions and concerns answered.

Franchise Disclosure Document for Dummies – Part 5

As a preliminary matter, it is important to understand the distinctions between trademarks, copyrights, patents and proprietary information.