Successful franchising requires more than hard work and a determination to succeed. You also have to know the rules for operation and how to handle things in case something goes wrong.
Fortunately, the franchisor’s franchise disclosure document, or FDD, provides almost all of the details both franchisor and franchisee will need to know.
There are 23 items in the FDD. In this blog, the fourth in a five-part series, I will explain briefly what items 15-18 cover.
- Obligation to Participate in the Actual Operation of the Franchise Business: This item depends on the kind of franchise under discussion. A home-based or service business is usually run by an owner-operator. In a restaurant franchise, that is rarely the case. There is almost always a general manager. That is particularly true in multi-unit franchise deals. It is always going to be an owner who then hires people to run the stores.
The general philosophy is that owner-operators pay more attention to the business. They really care because they have more at stake. Therefore, they will work harder to make their franchise more successful than a manager or someone else.
This item also details that if it is not an owner-operator run business, and you have a manager, does the franchisor require that the franchisee give the manager an equity stake in the business? You have to disclose whether you do or you do not. It is common to give a manager some kind of equity participation to encourage that individual to work harder than someone on a salary.
- Restrictions on What the Franchisee May Sell: If you have a single product franchise, you typically have to buy that product and only that product. It is usually a case of: Buy from us or from our designated supplier. Dunkin Donuts, for example, its franchisees have to buy it from Dunkin Donuts only. This item is not a big deal because you also talk about this subject matter in item 8. It reiterates that franchisees have to use that brand, or they will be in violation of the franchise agreement.
On the other hand, there are some franchises where there is no requirement at all. You can use anything. In the food business, there are often more restrictions than there are in a non-food business, like a service-based franchise, for example, which makes sense. In the food industry, franchisors want to exercise more brand control over the products that might be displayed or used in recipes.
- Renewal, Termination, Transfer, and Dispute Resolution: This is a very all-encompassing item. It talks about the franchisee’s renewal rights, what are the transfer or termination provisions, whether or not there is a covenant not to compete, if you have the right to sell your business, is there a right of first refusal, and more.
Before they changed the rule in 2008, this was not a chart. You basically copied from the franchise agreement and pasted it into the FDD. The chart makes it easier to read and to understand. It tracks all of the language. It also talks about whether there is an arbitration provision or not, what the venue is, what the choice of law is in the agreement. This is a pretty important section, but more so for the lawyers who read the FDD for franchisees than for the franchisees themselves.
To offer more details, renewal refers to the renewal term for the franchise agreement. For some it is 5, some 10, some 20 years. It depends on what deal the company uses. Termination refers to what franchisees have to do wrong to force a default notice and a termination. It is usually involuntary. Item 17 essentially talks about all the screw ups they could make that would result in this particular consequence.
Dispute resolution offers details in the event the franchisee or franchisor have a dispute against the other, and where it has to take place. That is almost always in the franchisor’s home state, and this item talks about whether there is mediation before arbitration or litigation. Some companies require it, others do not. I think it is a waste because nothing ever gets resolved. It is non-binding, and until you go to arbitration it is just an extra layer of expense and time. But some franchisors do require it.
- Public Figures: This refers to celebrities who have bought into the franchise; pro athletes do a lot of this. Look at Peyton Manning. He is a great example, he used to be the face of Papa John’s. If you have that kind of relationship with a public figure, then you have to disclose it, what is their compensation, and do they own any part of the company? Maybe 1 percent of the franchise companies in the country have this, but if you do then you have to disclose it.
Watch for the final part in this five-part blog series, where I will review FDD items 19-23.
If you need a franchise attorney, or you have more questions about a franchise disclosure document, click here.