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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.

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Your approach as a potential franchise buyer is to identify the real investment dollars you’ll need to get the franchise to profitability. The initial source of this information is Item 7 in the FDD. Item 7 is a schedule that details the estimated investment in the franchise. This schedule includes the cost of various items, including: the initial franchise fee, training related expenses, rent, insurance, professional fees for legal and accounting services, supplies, equipment, licenses and permits and additional working capital. Depending upon the specific franchise, there may be added categories. When reviewing the Item 7 schedule it’s important to know that franchisors are not required to list every type of fee or expense that might be part of the investment in the franchise but rather the likely investment needed to start the franchise. As you work to establish your investment number keep in mind the words “estimated” and “typical.” Item 7 is a guide, and as such, you should use this information accordingly.