What Is An FDD and How Does It Fit Into Starting A Franchise?

A franchise disclosure document is a legal document a franchisor must disclose to a prospective franchisee before a franchise sale. An FDD contains 23 disclosure sections including information about the franchisor, the potential sale, franchising fees, and information about the legal relationship between franchisor and franchisee. Franchise law requires a multitude of financial information disclosures as a safety net for all parties involved in a franchise deal.

An FDD must include these specific 23 sections, or items, disclosing various information to potential franchisees:

  • Item 1 must disclose corporate information, often including finances of parent companies.
  • Item 2 discloses business experience of a franchisor’s management team.
  • Item 3 requires disclosure of certain types of previous or litigation.
  • Item 4 discloses whether anyone on a franchisor’s management team has previously filed for bankruptcy.
  • Item 5 discusses any initial fees, while Item 6 discusses any additional fees.
  • Item 7 informs potential franchisees of their initial investment amount.
  • Item 8 requires franchisors to disclose restrictions on sources of products and services.
  • Item 9 requires a summary of legal obligations.
  • Item 10 discloses whether a franchisor offers financing for initial fees.
  • Item 11 informs franchisees of any assistance and training provided, especially for technology and software.
  • Item 12 has to do with whether franchisees are awarded a protected territory in which they control operations.
  • Item 13 discloses a company’s registration status with the United States Patent Office, and
  • Item 14 discusses information about any patents or proprietary information related to a franchise system.
  • Item 15 discloses required levels of commitment from franchisees, such as how involved franchisees should be in daily operations.
  • Item 16 defines any restrictions on what franchisees are allowed to sell.
  • Item 17 requires disclosure of legal rights and obligations for renewal, termination, or transfer of a franchised business.
  • Item 18 requires franchisors to disclose if any celebrities or public figures have been hired to promote their businesses.
  • In Item 19, franchisors must disclose in detail any financial performance representations.
  • Item 20 includes a summary of franchised and corporate outlets over the last three years, along with projections for the next year.
  • Item 21 discloses copies of franchisors’ financial statements.
  • Item 22 lists all contracts a franchisee must sign with a franchisor.
  • Lastly, Item 23 includes two copies of a receipt page, a document franchisees must sign to confirm all proper disclosures are included in an FDD.

Federal Franchise Rule requires that franchisees receive an FDD at least 14 days before a potential franchise sale. An FDD must be issued and updated annually within 120 days of a franchisor’s fiscal year-end. If any material changes in FDD information take place, an FDD must be updated quarterly. Franchisors must also renew their FDDs annually with state examiners. If approved by franchisees, franchisors can make changes to a franchise agreement without immediately amending an FDD, but amendments must still eventually be made.

As a part of Item 21, an FDD must contain a franchisor’s personal audited financial statements. Exceptions exist for first-time franchise sellers. An FDD must also include specific business information and financial statements regarding a company and its franchisees.

An FDD is essential to the success of a franchise sale. An FDD is both legally and practically necessary to build a trustworthy relationship between franchisor and franchisee. While lengthy and complicated, when completed properly, an FDD is extremely beneficial for both parties. One should not attempt to complete a franchise deal without a proper FDD.

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