Franchise Rule

Franchise Fundamentals: Taking a deep dive into the Franchise Disclosure Document

• The third in the FTC’s Franchise Fundamentals blog series walks through an essential part of that evaluation: an in-depth review of the Financial Disclosure Document (FDD) required by the FTC’s Franchise Rule.
• You must receive the Franchise Disclosure Document at least 14 days before you’re asked to sign any contract or pay any money to the franchisor or one of its affiliates.
• In fact, you have the right to the FDD once the franchisor has received your application and agrees to consider it.

Franchisor’s Background (FDD Item 1)

Item 1 provides background information about the franchisor and any parent companies, predecessors, and affiliates, including how long the franchise has been in business. It also lets you know if there are any legal requirements unique to the franchised business, like the need to get a special license or permit. This can help you understand the costs and risks you would be taking on.

Business Background (FDD Item 2)

Remember the old adage “People are known by the company they keep”? Well, companies are known by the people they keep, which is why Item 2 identifies directors, principal officers, and other key executives. Pay attention to their business backgrounds, their experience in managing a franchise system, and how long they’ve been with the franchisor.

Litigation History (FDD Item 3)

• Lawsuits against the franchisor could mean it hasn’t honored its agreements or that franchisees are dissatisfied with its performance.
• Item 3 also says whether the franchisor has sued any of its franchisees in the past year.

Bankruptcy (FDD Item 4)

Have the franchisor, its affiliates, or any of its executives filed for bankruptcy? Item 4 discloses that information and could give you insights into the financial condition of the business. 

Initial and Other Fees (FDD Items 5-7)

• Items 5-7 go over some of the costs involved in starting and operating a franchise.
• That could include things like deposits or franchise fees (some of which may be non-refundable); what you’ll have to pay for initial inventory, signs, equipment, leases, or rentals; and ongoing costs, like royalties and advertising fees.

Supplier, Territory and Customer Restrictions (FDD Items 8 and 12)

• Does the franchisor limit what goods and services you can offer?
• Must you buy from particular suppliers designated by the franchisor?
• Also, a franchisor may limit your business to a specific location or sales territory.
• Are you OK with restrictions that may limit your ability to exercise your own business judgment?

Advertising and Training (FDD Item 11)

• Advertising and training can have a significant impact on a franchisee’s bottom line.
• Franchisors often require franchisees to contribute a portion of sales to advertising funds.
• Item 11 also includes information about training.
• Talk to recent franchisees to get their take on the quality of the training.

Renewal, Termination, Transfer, and Dispute Resolution (FDD Item 17)

• Find out about the renewal process – what do you have to do to qualify for renewal and will fees or other contract terms change?
• If you have a dispute with the franchisor, can you go to court or must you use arbitration instead?

Financial Performance Representations (FDD Item 19) 

• But here’s the important thing: Any claims of that nature must be in Item 19.
• And if the claims aren’t in Item 19, the franchisor – as well as brokers, dealers, or other sellers – can’t make any spoken or written financial performance claims.
• So if a franchisor or other seller makes financial claims that aren’t included in Item 19, that should set off your baloney detector.

Franchisee and Franchise System Information (FDD Item 20)

• Item 20 provides charts showing growth and owner turnover in the franchisor’s system.
• Item 20 also unlocks a key source of highly relevant data: contact information for current and former franchisees.
• Although some may have signed confidentiality agreements, if they’re willing to talk, ask if they had problems with their outlet, if they made a profit, and why they left the franchise system.
• Item 20 also lists the franchisee associations sponsored by the franchisor.

Financial Statements (FDD Item 21)

• Item 21 provides the franchisor’s three most recent audited annual financial statements.
• Even if you’re comfortable reading financial statements, it’s a good idea to hire an accountant to go over them with you.

Contracts (FDD Item 22)

• At the request of several interested parties, the Commission extended the original May 9, 2023 public comment period for 30 days, until June 8, 2023.
• The FTC announced the Request for Information on March 10.
• Separately, the FTC is seeking public comment on a proposed rule to ban noncompete clauses for workers in some situations.
• Follow the FTC on social media, read consumer alerts and the business blog, and sign up to get the latest FTC news and alerts.

• The Federal Trade Commission requests comment on franchise agreements and franchisor business practices, including how franchisors may exert control over franchisees and their workers.
• The FTC would like to know more about how franchisors may exert control over franchisees and their workers.
• Apart from this Request for Information, the FTC is seeking public comment on a proposed rule to ban noncompete clauses for workers in some situations.
• Follow the FTC on social media, read consumer alerts and the business blog, and sign up to get the latest FTC news and alerts.

• For many Americans, owning a fast food franchise seems like a promising way to secure their financial future.
• The defendants also promised to help franchisees customize your location, hire a small team, and generate wealth.
• The defendants also promised to help franchisees customize your location, hire a small team, and generate wealth.
• In addition, the complaint alleges that the defendants made financial performance claims to prospective franchisees, but failed to put those statements in the Financial Disclosure Document, as the Franchise Rule requires.
• Whats more, the FTC and DOJ say Burgerim made claims in the disclosure document that contradicted things they said to prospective franchisees.
• The lawsuit alleges that the defendants violated the FTC Act by falsely representing that they would refund the franchise fee of franchisees who werent able to get financing or a restaurant location.
• The lawsuit alleges that hundreds sought to cancel their franchise agreement, but the defendants didnt honor their refund promises.
• Take it slooooow.Buying a franchise is a major financial commitment incompatible with fast talk, high pressure, and quick decisions.
• Seek out franchisees and ask the tough questions.Contact the franchisees (or former franchisees) included on the Financial Disclosure Document and ask in-depth questions about their experience.
• Franchisees, have you spotted a questionable business practice the FTC should know about?