Investing in a franchise is a serious financial decision. Franchisees will need to learn as much as they can about their potential business partner, the franchisor. They will also have to become knowledgeable about the details in that franchisor’s franchise disclosure document, or FDD. The FDD details the franchisee-franchisor relationship so that franchisees know exactly what their obligations are, and they are fully informed about any potential red flags – such as past or present litigation – that might be attached to that franchisor.
- Financing: Most franchisors will not provide financing. Nor will they recommend lenders that franchisees can approach to get a loan. Franchisors want to stay away from that. If they recommend a lender and something happens, the franchisee could turn around and complain: “You gave me that lender, but they would not lend me the money.” Franchisors have to be careful. Also, if the franchisor takes any commissions or referral fees those will be disclosed in item 10.
- Franchisor’s Assistance, Advertising, Computer Systems and Training: This is important for franchisees because it explains all of the obligations the franchisor has to provide for them in those various categories. This item also includes the training schedule, any computer specifications needed as well as any advertising fund contributions required.
Franchisees should to pay close attention to this one. It is important for them to know how long the training schedule is, for instance. Is it a month or two days? It also identifies who the trainers are and how long they have been doing the training for the franchisor. In terms of computer systems, will the franchisee have to buy a HP, a Mac, or a POS system? If there is a franchise advisory council – the governing body franchisees use to communicate any issues they may have to the franchisor – it will also be discussed in this item.
- Territory: This is also important. This item will detail if the franchisor grants exclusive territories. If they do not, this item will state that as well. It also discloses whether or not the franchisor can compete in other channels of distribution. This item is more important in the food industry over the course of time than in other industries because it talks about where else someone could buy that franchisor’s product or products.
For example, Carvel sells ice cream in supermarkets and convenience stores, but a franchisee could have a retail operation right across the street from one of these establishments. Dunkin Donuts is a similar example. The popular coffee franchise now sells its products in supermarkets as well.
Item 12 also details whether or not the franchisor will grant the franchisee the right of first refusal. If there is a franchise candidate in the pipeline for a location near an existing franchisee, the franchisor may grant the established franchisee the right to open up that location instead. If they say no, it goes to the new franchisee. This item will also state whether or not a multi-unit operator gets a territory, rather than just a single unit.
This item also discusses if there is a sales volume quota. Franchisees will find this in a lot of service-oriented or home-based businesses. For example, if they do not generate a certain sales volume in their second year of operation, there is a chance they could lose their territory or have it reduced. A franchisor will not want to tie up a valuable territory to an underperformer.
- Trademarks: This is pretty black and white. All principal or primary trademarks that franchisees have to use that are registered, unregistered, or that franchisors have to apply for have to be listed in this item. If there is any trademark litigation, infringement actions or license agreements, those have to be disclosed in item 13 as well. This section also describes any limitations on the use of a particular mark, or if there are others who use a similar or the same mark in their areas.
- Patents, Copyrights, and Proprietary Information: This is the same principal idea as is discussed in item 13, but the subject matter is related to patents and copyrights. Any litigation or requirements will be listed here. The franchisor also must include a patent’s status and whether there are any oppositions to the applications.
Watch for the fourth part in this five-part blog series, where I will review FDD items 15-18.
If you need a franchise attorney, or you have more questions about a franchise disclosure document, contact Harold Kestenbaum today.