Franchise Disclosure Document for Dummies – Part 7
In part seven of this series on understanding the FDD, we continue with Items 17, 18 and 19. Item 17 provides an overview of key provisions of the franchise agreement, Item 18 addresses use of public figures to promote the franchise, and Item 19 covers Financial Performance Representations (one of the most interesting, but ultimately poorly understood, Items that potential investors seek when exploring franchise opportunities).
Item 17 – Key Provisions of the Franchise Agreement
In Item 17 of the FDD, franchisors are required to provide summaries and cross-references for 23 key provisions in the franchise agreement. A careful franchise prospect will have the entire franchise agreement reviewed in-depth by an experienced franchise attorney, but the Item 17 disclosures can provide a quick guide to use in a preliminary analysis of the franchise opportunity.
Some of the Key Franchise Agreement Provisions Summarized in Item 17 Include:
- Renewal and transfer rights
- Franchisor and franchisee rights of termination
- Non-competition obligations (in-term and post-term)
- Dispute resolution provisions
Item 18 – Public Figures
Item 18 requires disclosure of any public figure “whose name or physical appearance is generally known to the public in the geographic area where the franchise will be located.” Importantly for franchisors, Item 18 applies only if the public figure engaged for the purpose of selling franchises—using public figures to promote franchisees’ products and services—does not trigger an Item 18 disclosure.
However, if the public figure promotes franchisees’ products and services and also invests in the franchisor, then the public figure’s investment must be disclosed in Item 18.
Item 19 – Financial Performance Representations
Entire scholarly articles can (and have been) written on the subject of Financial Performance Representations (“FPRs”). Franchisors who provide FPRs in their FDDs do so with careful guidance from their legal and financial advisors, and state franchise examiners often heavily scrutinize these disclosures. While certain disclaimers and limitations can (and should) be included, there are limits on the lengths to which franchisors can go to effectively nullify the legal consequences of providing an FPR in the FDD.
There are two main types of Financial Performance Representations:
- Historical financial data based on the performance of franchised or company-owned outlets
- Projections of potential future performance
If a franchisor provides historical data, it may provide information for all outlets or a certain defined subset. However, it may not simply disclose the financial results of its top-performing franchisees.
Limited historical disclosures must be based on categorizations such as:
- Geographic location
- Years in operation
- Nature of location (e.g., free-standing versus shopping center)
If a franchisor provides an FPR, it must carefully train its sales staff to limit their discussions with franchisees to stay within the scope of the FPR. Federal and state franchise laws prohibit franchisors from making any financial performance representations other than those included in the FDD.
Franchisors also have the option not to provide any FPR in the Franchise Disclosure Document, and this option has been gaining popularity in recent years. If a franchisor provides this “negative” disclosure in the FDD, it may not provide any financial information to prospective franchisees.
Next week’s installment will be the final chapter in this series, and will cover the system size and growth data in Item 20, franchisor financial statements in Item 21, and the Receipt pages that comprise Item 23.
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 firstname.lastname@example.org. 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.
Before Buying a Franchise Identify Your TRUE Investment
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.
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