What to know as a franchisee
The franchise disclosure document (FDD) can be overwhelming to a franchisee in the hospitality industry. Some well-known franchisors file FDDs that are almost 400-500 pages in length. Simply knowing where to start can be daunting.
For starters, the franchisee must discriminate between critical points and boiler-plate language. Additionally, some states require that the franchisor register an FDD, while others do not. Reviewing an FDD carefully is critical, as a franchisee is committing to a long-term relationship with the franchisor and this will impact all future business.
1. HISTORY 101
FDDs were first utilized in California in the 1970s to provide franchisees with essential information about the franchisor, its business, and the franchise agreement offered. California sought to protect potential franchisees against fraud and misrepresentation by providing them with essential information regarding the franchise prior to the franchisee entering into a business relationship with the franchisor. This protection was later codified into federal law to ensure that franchisors provided adequate pre-sale disclosure to franchisees. While each state that requires franchisors to register with them has their own specific process for filing FDDs, many of those states follow the 2008 NASAA Guidelines, which standardized the forms and application process when registering or renewing an FDD.
After California created its franchise law, so did 13 other states. Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, South Dakota, Rhode Island, Virginia, Washington, and Wisconsin have all implemented franchise laws. Along with California, these are considered the franchise registration states. Some of these states and others also have what are known as business opportunity laws, which apply to the offer and sale of franchises but do not necessarily require registration of the franchise offering with the applicable state.
2. FDD STRUCTURE
The FDD starts with a general cover page and state cover page. After these cover pages, there are 23 items that cover topics such as the business experience of the franchisor, the franchisor’s litigation and bankruptcy history, initial fees associated with entering into the business relationship, territory rights, and the franchisor’s financial statements. Following items 1-23, there are specific state disclosure documents. It is common practice for a franchisor to use a standard FDD for all states and attach state-specific information at the end of the FDD.
3. HITTING THE HIGH POINTS
The FTC requires that disclosure must be provided to a prospective franchisee no less than 14 days prior to the execution of any binding documents or the franchisee’s payment of any consideration. Franchisees should take ample time to review the document. These are some of the key components of the FDD that should be carefully reviewed by the franchisee:
It is important for the franchisee to have a full picture of the total scope of investment associated with entering into a business relationship with the potential franchisor.
The information in these items should be considered before a franchisee signs the franchise agreement. For example, if a franchisor has an excessive litigation history or their financial statements show instability, this should be carefully evaluated.
This gives a prospective franchisee an idea as to the growth or lack thereof of a franchise system. If there are many terminations in a system, that would certainly raise concerns about the health of the system. Franchisees also are required to list information regarding terminated properties. It’s recommended that prospective franchisees reach out to terminated franchisees to see why they ended their business relationship with the franchisor.
As the purpose of the FDD is to provide a clear picture of the franchisor’s businesses practices, it’s important to review the FDD thoroughly. There are many factors to consider before entering into a business relationship with the franchisor. Franchisees should also review the franchisor’s litigation and financial history to understand the franchisor’s business practices. Once the franchisee understands the FDD’s purpose and structure and can pinpoint important sections for review, the FDD is not as daunting a document as it may seem. It’s recommended, however, that a franchisee review the FDD with an experienced franchise attorney before entering into a business relationship with the franchisor.
Jaclyn Saltzman, Esq., is an Associate Attorney at Saltzman Law Group and works with a variety of clients in the franchise space, focusing on FDD matters in the hospitality industry.