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Breaking down the FDD

What to include, what not to include and everything in between...

After weeks of preparation, financial audits and legal review, time has come to register your Franchise Disclosure Document. Now, before you do ask yourself: Did I cross my T’s and dot my I’s?

There are few things in the world of franchising as complex as developing, finalizing and registering the FDD and even what may appear to be minor missteps could have troublesome effects on your franchise registration process.

Getting it right the first time around is critical for the future of your franchise, so consider these decisive steps in finalizing your FDD.

Understanding the disclosure

The first step in developing an FDD is understanding what it is and the purpose it serves in your franchise program. Originally known as the Uniform Franchise Offering Circular (UFOC), a franchise disclosure is a legal document that outlines the specific elements of your franchise program – 23 items to be exact. In 1979, the Federal Trade Commission developed the Franchise Rule to ensure franchisors were transparent with their offering in an effort to protect franchisees and their understanding of the franchisor/franchisee relationship, the reputation of the company, and the performance of existing business, among a number of other things.

It is a highly complex document that must feature precise wording and must adhere to state-specific addendums. Each company’s FDD contains unique details to the business, but all of these documents are laid out in the same prescribed format. Every FDD must include the following sections, or items:

1. The Franchisor and Any Parents, Predecessors, and Affiliates

2. Business Experience

3. Litigation

4. Bankruptcy

5. Initial Fees

6. Other Fees

7. Estimated Initial Investment

8. Restrictions on Sources of Products and Services

9. Franchisee’s Obligations

10. Financing

11. Franchisor’s Assistance, Advertising, Computer Systems and Training

12. Territory

13. Trademarks

14. Patents, Copyrights, and Proprietary Information

15. Obligation to Participate in the Actual Operation of the Franchise Business

16. Restrictions on What the Franchisee May Sell

17. Renewal, Termination, Transfer, and Dispute Resolution

18. Public Figures

19. Financial Performance Representation

20. Outlets and Franchisee Information

21. Financial Statements

22. Contracts

23. Receipts

Reviewing with a fine-tooth comb

While several FDD items are straightforward in disclosure (like the franchisor description, business structure and existing locations) there are some elements of the legal document that should be thoroughly reviewed by your team and franchise attorney. This review is intended, in large part, to protect your business entity as you will be held liable for any and all statements you make within the FDD.

Some especially sensitive items include Item 7 (estimated initial investment), Item 12 (territory options), Item 19 (financial representation), and Item 22 (franchisee contracts). Not only will these items dictate the course of the agreement with your franchisees, but also act as a significant marketing piece in your ability to differentiate your opportunity from competitors.

But, be weary – if you plan to use these items in your marketing program, you must abide by the exact language that is written in your FDD. Far too often franchisors promote the potential return on investment or tout protected territories when those things are not indicated in the FDD. That is a big red flag in the legal world, but it should not be a deterrent to include financial performance in your FDD.

Protecting your franchise future

Fear often prevents emerging and even some established franchisors from including anything in their Item 19, and it is an understandable choice to make. Listing financial performance indicators in the Item 19 is not a requirement under the Franchise Rule. However, if you do decide to include information within your Item 19, the disclosure must follow a specifically prescribed format, one that has recently changed.

Establishing (or not establishing) your Item 19 is not the only non-required element of your FDD. Some franchisors also opt for offering exclusive or protected territories in an attempt to entice prospects. If you intend to go that route, it must be clearly indicated in the disclosure, spelling out territory size and what protections are included. Before deciding to offer exclusive territories, first take into account any potential business conflicts, growth limitations or the reservation of certain rights that may result in your decision.

One final step in developing your FDD will also include estimating a franchisee’s initial required investment. This is a great opportunity to attract prospects if you are offering a low-cost franchise but be careful not to underestimate or under-represent the high end of your initial investment. Misrepresentation of this range can often be a source for legal or contractual disputes.

Even though registering an FDD can feel like exposing confidential information about your franchise program, keep in mind that thorough documentation is important in protecting you, your organization and your franchisees.

Harold L. Kestenbaum, Esq. Partner, Spadea Lignana Attorneys at Law
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