This is Part 3 of our three-part series, Understanding Your Franchisor’s FDD. Here, we cover some of the highlights of Items 15 through 23. For our discussion of Items 1 through 14, you can read:
- Understanding Your Franchisor’s FDD – Part 1 (Items 1 through 7)
- Understanding Your Franchisor’s FDD – Part 2 (Items 8 through 14)
Item 15: Obligation to Participate in the Actual Operation of the Franchise Business
What You’ll Find
Any restrictions the franchisor imposes regarding who can take responsibility for the day-to-day operation of the franchised business.
Why You Care
While some franchisors do not require their franchisees to have direct involvement in their outlets’ day-to-day operations, others do. If your franchisor requires direct, “on-premises” supervision, this is certainly something you will want to know (especially if you are looking for a multi-unit opportunity).
Item 16: Restrictions on What the Franchisee May Sell
What You’ll Find
Any requirements to sell only approved goods or services, as well as any requirements to sell all goods or services authorized for sale at franchised outlets.
Why You Care
If your franchisor limits your inventory or service offerings, this is something that you will need to take into consideration when evaluating the financial potential of your franchise. Likewise, if your franchisor requires you to carry all approved products, is this going to leave you paying for inventory that just ends up going to waste?
Item 17: Renewal, Termination, Transfer, and Dispute Resolution
What You’ll Find
A table that identifies where you can find key terms in your franchise agreement (such as termination and renewal rights), as well as summaries of each of these key terms.
Why You Care
If you are struggling to find a particular clause while wading through your franchise agreement, you may find the Item 17 table helpful. While you can read the franchisor’s summaries of the agreement’s terms for informational purposes, you should not rely on the summaries as a substitute for obtaining independent legal advice.
Item 18: Public Figures
What You’ll Find
Information on any sponsorship or endorsement deals the franchisor has signed with public figures (such as actors, musicians or athletes).
Why You Care
Item 18 disclosures are relatively rare. But, if your franchisor has entered into an endorsement or sponsorship agreement with a public figure, analyzing Item 18 and asking follow-up questions can help you get a better idea of the value (if any) that the relationship brings to the franchise system.
Item 19: Financial Performance Representations
What You’ll Find
Either (i) a “negative disclosure,” which states that the franchisor does not provide financial performance representations; or, (ii) a substantiated disclosure of the actual or potential financial performance of some or all of the system’s company-owned and/or franchised outlets.
Why You Care
If your franchisor provides a financial performance representation (formerly known as an “earnings claim”), you will probably want to take it with a grain of salt. Most financial performance representations come with a host of caveats and disclaimers, and they rarely provide reliable insight into what any one franchisee can expect to earn. That said, it is certainly worthwhile to review any affirmative disclosures provided in Item 19 and attempt to validate them with current and former franchisees.
Item 20: Outlets and Franchisee Information
What You’ll Find
Tables (with accompanying footnotes) that provide three years’ worth of data regarding: (i) franchise openings and closings, (ii) transfers, (iii) terminations and non-renewals, and (iv) company-owned outlet openings and closings. There is also a fifth table that discloses the franchisor’s projections for new openings over the coming year.
Why You Care
Prospective franchisees can glean a lot of useful information from Item 20. Pay particular attention to any major fluctuations as well as the numbers for “Ceased Operations-Other Reasons” – which often means that a franchisee went out of business due to lack of profitability.
Item 21: Financial Statements
What You’ll Find
Audited financial statements for the franchisor’s last three fiscal years (except for new franchisors, which are allowed to follow a “phase-in” approach).
Why You Care
When you buy a franchise, you want to know that the franchisor is financially secure. An experienced accountant will be able to help you make sense of the franchisor’s audited (or unaudited) financials.
Item 22: Contracts
What You’ll Find
A list of the contracts you will be required to sign if you purchase a franchise.
Why You Care
You will want to make sure you have copies of all relevant agreements so that you can provide them to your attorney for review.
Item 23: Receipts
What You’ll Find
Two copies of a one-page “receipt” that you will be required to sign when you receive the Franchise Disclosure Document (FDD).
Why You Care
Federal regulations require all franchisors to obtain a signed FDD receipt from each prospective franchisee. As noted on the receipt page, you must receive the FDD at least 14 calendar days before signing the franchise agreement or making any payment to the franchisor in order for the franchisor to remain in compliance (note that some states have different minimum disclosure periods).
Inquire about a Fixed-Fee Franchise Review from the Goldstein Law Firm
If you are considering a franchise opportunity and need assistance reviewing the franchisor’s FDD or franchise agreement, we encourage you to contact us to learn about our fixed-fee franchise reviews. To speak with national franchise lawyer Jeffrey M. Goldstein, call the Goldstein Law Firm at (202) 293-3947 or send us a message online today.
