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Franchise Disclosure Document for Dummies – Part 6

franchise disclosure documents items 15 and 16

In part six of this series on understanding the FDD, we continue on with Items 15 and 16. Item 15 discloses franchisees’ operational obligations and limitations, and Item 16 covers limitations on the products and services that franchisees can offer for sales.

Items 15 and 16 are two of the shorter Items in the Franchise Disclosure Document. However, they – and Item 15 in particular – still contain critical information for prospective franchisees to consider evaluating potential franchise opportunities.

Item 15 – Obligation to Participate in the Actual Operation of the Franchised Business

The key disclosure in Item 15 states whether the franchise owner is obligated to participate in the direct operations of the franchised business. For prospective franchisees looking for a pure investment rather than a business opportunity, this disclosure might be the first (and only) provision they read in the FDD. Although, an experienced franchise investor may be able to negotiate an exception with the franchisor.

Other Item 15 disclosures include:

  • If participation is not required, whether or not it is recommended
  • Any mandatory limitations for franchisees’ on-premises managers and supervisors (such as training obligations, confidentiality agreements and non-competition covenants)
  • Any requirement for the franchisee’s managers or supervisors to own an equity interest in the franchise

While often overlooked, this final issue can be an important one for both franchisors and franchisees. By requiring day-to-day managers to literally buy-in to the franchise, franchisors and franchisees can help make sure that these essential personnel have an incentive to help grow the business instead of merely showing up to collect a paycheck.

Item 16 – Restrictions on what the Franchisee may Sell

Item 16 contains fairly straight-forward disclosures, including:

  • Whether franchisees may only sell franchisor-approved goods/services
  • Whether franchisees must sell all franchisor-approved goods/services
  • Whether the franchisor reserves the right to modify the list of approved goods/services (it should)

For service-based franchises, the franchisor will almost always limit the scope of services franchisees can offer, as the service offering will often be the underlying concept for the entire franchise system. For restaurants and other product-based franchises, depending on the franchisor’s concept (and depending on whether the franchisor itself sells products to franchisees), the franchisor may limit franchisees’ sourcing options, or it may grant some leeway—subject to inspection, standards compliance, etc.—to use substitute or local products and suppliers.

Next week’s installment will focus on Items 17, 18 and 19 of the FDD, which cover the franchise agreement, use of public figures to promote the franchise, and financial performance representations.

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.

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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:

What is Subfranchising?

Like the franchisor, the subfranchisor signs a subfranchising agreement with the franchisees (when a franchise is sold) in the area. Technically, the subfranchisor takes over the role of the franchisor in certain geographic regions.

Top 5 Reasons to Join an Emerging Franchise

Investing in any franchise is a risk. You’re counting on franchisors for guidance; other franchisees for support and you’re investing a ton of money to build your business. Now add the risk factor of investing in an emerging franchise, a franchise with only a few franchisees. Does it add risk? Maybe, but there are far more benefits of investing in an emerging franchise that the little added risk, is a fleeting concern. Your voice is not only heard by the franchisors, but it’s also helping to make positive changes for future franchisees. Take a extremely large franchise such as, McDonalds or Hilton. Can you imagine a franchisee picking up the phone to call the President of the company to share an idea they had on how to make franchisees daily operations more efficient? In an emerging franchise, you are able to have a close relationship with the corporate team behind the concept and your ideas will be taken seriously. They believe in you as much as you believe in them. Here are five more reasons to join an emerging franchise: