Turning your business into a franchise is an exciting process for you and future franchisees. An essential part of creating a franchise is drafting your franchise disclosure documents, often referred to as FDD. These documents help you determine whether your business should be turned into a franchise and how to plan the transformation.
The FTC created this document in response to a number of complaints. In years past, salespeople would convince franchisees to invest in a franchise without all the necessary information. This caused many people to lose their investments.
Now, the FTC states that franchisors must give potential franchisees the FDD at least 14 days before any contracts are signed or any money is exchanged, so the franchisee can make an informed decision about their investment.
Franchise disclosure documents have a very specific format, divided into 23 sections that cover all the information a potential franchisee might need to make an informed decision and sign a contract.
FDD sections explained
Below are the 23 sections that are required for a Franchise Disclosure Document and a brief explanation of what each of those sections cover.
1. The franchisor and any parents, predecessors, and affiliates
This section covers the history of your franchise business, any parent company or companies that have come before the current franchise. This is also where you give an overview of your business model, the competition, and an offer to become a franchisee.
2. Business experience
Provide the backgrounds of key directors, officers, managers and employees who have played a large role in the sale and management of the franchise. This section is all about giving an introduction to the key players in the franchise and reviewing their past business experiences.
In this section, discuss any past or current litigation your franchise has been involved in. This level of transparency is critical for earning your franchisees' trust and making sure they're well-informed.
Here, you discuss any bankruptcy that has occurred within the business. This includes not just bankruptcy that's occurred within the company, but also to any of the key people involved in the franchise.
5. Initial fees
This is where you outline any of the deposits and fees the franchisee will have to pay in order to gain ownership and start up their own franchise within your business.
6. Other fees
Here, you outline the fees that will continue for as long as they own and operate the franchise. What ongoing royalties or yearly fees will you charge your franchisees for advertising, renewal of their ownership, or transfers? Make sure you provide a complete and accurate list.
7. Estimated initial investment
This section covers any costs the franchisee will incur to get the franchise up and running. This includes advertising, the cost of operations, and any other costs that may arise before the franchisee starts making revenue.
8. Restrictions on sources of products and services
This is where you include any restrictions you have regarding the sources and types of products and services offered through your franchise.
9. Franchisee's obligations
In this section, you provide a clear reference to all the obligations the franchisee is agreeing to when they sign this contract.
Here, you describe any financing options or programs available through the franchise.
11. Franchisor's assistance, advertising, computer systems, and training
This section details the obligations you have as a franchisor when you sign a contract with a franchisee. This section tends to be the longest, as it includes any assistance you offer before their business is open, as well as any ongoing assistance. In this section, you also outline any advertising assistance that will be provided for the franchisee.
Include information regarding any franchisee training programs offered through the franchise, as well as the support offered through the computer systems used throughout the business.
This section covers any territory offered to the franchisee and whether the territory will be changed because of this agreement. This section is going to vary greatly between different franchises, as each has its own philosophies regarding territory.
Here, you include information regarding your franchise's trademarks.
14. Patents, copyrights, and proprietary information
Similar to the previous section, this section outlines information regarding the patents, copyrights and other information about how the franchisee can use these copyrighted materials.
15. Obligation to participate in the actual operation of the franchise business
In this section, you explain the personal obligations the franchisee will have in the actual operation of the business. These can vary greatly, so be specific.
16. Restrictions on what the franchisee may sell
This is where you outline any products or services the franchisee cannot offer from their franchise locations. These restrictions will determine what franchisees can or cannot offer at their location.
17. Renewal, termination, transfer, and dispute resolution
This section covers the costs or renewal, termination or transfer for franchisees. This is also where you cover how you and franchisees will handle disputes. These policies are critical to running a smooth franchise operation with as few disruptions as possible.
18. Public figures
If you use public figures (e.g. celebrities or public persons) for advertising or promotions, then state the amount they are paid here.
19. Financial performance representations
This section is where you provide information regarding the financial performance of other franchise units. According to Entrepreneur:
"The typical Item 19 disclosure consists of three types of information: 1) numerical presentations of revenue and/or expense data, 2) notes and explanations outlining the assumptions used in preparing these numerical presentations, and 3) disclaimers that carefully explain the limitations of the usefulness of the data presented."
20. Outlets and franchisee information
This section lists information about all the other units within the franchise. This includes updated contact information for each unit, such as addresses and phone numbers.
21. Financial statements
This is where you include audited financial statements from the last three years.
This is where you should put all the contracts the franchisee will be required to sign. Organizing your contracts this way makes it easier to find and reference them later.
Franchisees are required to sign a receipt stating that they received the FDD. This protects your business and proves to the FTC that you did your due diligence. It will be placed at the end of the FDD.
Your franchise disclosure documents are vital to maintaining your business' health and your franchisees' success. It's important that you keep this document in order, up-to-date, and written in clear, concise language.