What Is a Franchise Disclosure Document (FDD)?
The franchise disclosure document (FDD) is a legal disclosure document that must be given to individuals interested in buying a U.S. franchise as part of the pre-sale due diligence process. The document contains information essential to potential franchisees about to make a significant investment.
The FDD was previously known as the Uniform Franchise Offering Circular (UFOC) before it was revised by the Federal Trade Commission (FTC), the country's consumer protection agency, in July 2007. Franchisors had until July 2008 in order to comply with the revisions. The FDD has also been referred to as the Uniform Franchise Disclosure Document.
- The franchise disclosure document (FDD) provides a clear picture of how the business relationship between the franchisee and franchisor will be conducted.
- Franchises can be very different in the support they offer in return for licensing fees.
- The FDD is a critical source of information when evaluating whether to become a franchisee, and the FTC has made the document a legal requirement.
Understanding a Franchise Disclosure Document (FDD)
The FDD outlines comprehensive information about the roles of both parties involved in the franchise—the franchisor and the franchisee—and is designed to enable the potential franchisee to make an honest and informed decision about their investment into the business. The document lays out how the investment will work in practice for the potential franchisee, which is critical because a franchise is a different type of investment/business.
A franchise is a license that a party (the franchisee) acquires to allow them to have access to a business's (the franchisor) proprietary knowledge, processes, and trademarks. This gives the franchisee the ability to sell a product or provide a service under the business's name. In exchange for gaining the franchise, the franchisee usually pays the franchisor an initial start-up and annual licensing fees.
The franchisor may help the franchisee with finding a location, training, and advice on management, marketing, or personnel. The relationship does not necessarily end after the initial start-up, either. The franchisor may also provide support through newsletters, a toll-free telephone number, a website, or scheduled workshops or seminars. Because franchises can be so varied in their approach, the role of the FDD is to explicitly lay out what will and will not be provided to the franchisee and how the relationship will work going forward.
It is worth noting that, although buying a franchise may come with training, support, and brand power, it is like any other investment—there is no guarantee of success. Anyone who may entertain the idea of opening up a franchise should carefully weigh the pros and cons before doing so. The FDD is a critical source of information for that evaluation process.
Requirements for a Franchise Disclosure Document (FDD)
The FDD is divided up into 23 sections and the potential franchisee must review each of them before signing.
According to the FTC, franchisors have an obligation to provide the franchisee with the FDD at least 14 days before it needs to be signed or before any initial money is exchanged. The franchisee has a right to a copy of the FDD after the franchisor has received the application and agreed to consider it.
Sections of the Franchise Disclosure Document (FDD)
The FDD contains information essential to potential franchisees about to make a significant investment. Each document is required to contain the following sections in the order specified below:
- The franchisor and any parents, predecessors, and affiliates: This section establishes how long the franchisor has been operating.
- Business experience: Outlines the experience of the executive team running the franchise system.
- Litigation: Covers pending actions, material actions, and prior actions against the franchise.
- Bankruptcy: Bankruptcies involving the franchise, its predecessors, and its affiliates must be disclosed.
- Initial fees: A franchisor must disclose any fees charged to franchisees.
- Other fees: Hidden or undisclosed fees can be a source of dispute later on down the road, so a franchisor must be careful to reveal all charges and be fully transparent.
- Estimated initial investment: The franchisee must be aware of what the low and high range of the initial investment must be, including an estimate of their working capital.
- Restrictions on sources of products and services: Covers any required purchases of goods and services, in addition to disclosing any ownership or financial relationship between the franchise and required suppliers.
- Franchisee’s obligations: Lays out the franchisee's obligations in a reference table.
- Financing: Outlines the conditions of any financing arrangements.
- Franchisor’s assistance, advertising, computer systems, and training: Explains the pre-opening and ongoing assistance that the franchisee can expect from the franchisor.
- Territory: While there is no obligation to give a franchisee any range or territory to do business, this is the space to indicate any geographical restrictions a franchisor is putting on the franchisee.
- Trademarks: Discloses the trademarks registered to the franchise.
- Patents, copyrights, and proprietary information: This section discloses patents, copyrights, and other protected information not covered under the trademarks section.
- Obligation to participate in the actual operation of the franchise business: This makes it explicit whether the franchise can be held as an arms-length investment or whether direct participation is expected.
- Restrictions on what the franchisee may sell: Covers whether only franchise approved goods and services can be sold.
- Renewal, termination, transfer, and dispute resolution: Outlines the described processes.
- Public figures: Covers any person whose name or physical appearance is associated with the franchise. For example, a particular celebrity who appears in franchise commercials.
- Financial performance representations: An optional space for a franchisor to estimate a franchise's potential performance based on reasonable assumptions.
- Outlets and franchisee information: Where the franchise stats are disclosed as to the number of company-owned outlets and franchised outlets in operation for the last three years.
- Financial statements: A franchisor must provide three years of financial statements to the franchisee as part of the FDD. This includes balance sheets, statements of operations, owner’s equity, and cash flows.
- Contracts: This is where the franchisor outlines the franchise agreement. It may also include financing agreements, product supply agreements, personal guarantees, software licensing agreements, and any other contracts specific to the franchise's situation.
- Receipts: This is the final section of the FDD. Here, the franchisor will review the disclosure and business decisions outlined between the two parties and provide the franchisee with any additional information.