Franchising is regulated by the Federal Trade Commission and by state laws. As a franchisor, you are required to provide accurate, detailed disclosures to prospective franchisees so they can make informed decisions about your franchise offer. These legal documents, along with the operating manuals, staffing, training programs, and marketing initiatives, are your main investments in the franchise system.
The two primary documents you’ll create are the Franchise Agreement and the Franchise Disclosure Document (FDD).
The Franchise Agreement
The franchise agreement is the binding contract between you and your franchisee. It explains all rights and obligations for both parties and protects the integrity of your franchise system and your trademarks. This is one of the first documents you will send to a prospective franchisee.
A good franchise agreement will be concise, clear, and fair. Issues typically addressed in a franchise agreement include:
- Initial and ongoing franchise fees
- Timelines for opening the franchise for business
- Franchise territory protections (if applicable)
- Specifications for equipment, supplies, and inventory
- The term of the agreement and conditions for its renewal
- Rules regarding the transfer of the franchise to a third party
- Conditions for termination of the agreement
- Post-termination obligations
- Non-compete covenants
- Minimum sales requirements (if applicable)
- How disputes are to be resolved, including alternative dispute resolution methods such as mediation and arbitration
The Franchise Disclosure Document
A Franchise Disclosure Document (FDD) must be prepared in strict compliance with FTC rules. By law, you can’t sell a franchise until you’ve given the prospective franchisee an FDD. In fact, 15 states require franchisors to register their FDDs with the state or to notify them that they will offer franchises before they begin to conduct any franchising activity in the state.
The FDD discloses extensive information about you and your business, divided into a cover page, table of contents, and 23 categories, including:
- The franchisor. How long you’ve been in business, likely competition, and any special laws that pertain to your industry, such as license or permit requirements.
- Key persons. The identity and experience of executives and key management personnel.
- Litigation history. A discussion of all litigation involving your company and other franchisees or customers, and disclosure of any allegations of fraud or violations of franchise laws.
- Bankruptcy. If you or any of your executives has filed for bankruptcy, it must be disclosed here.
- Initial franchise fee. Lists the costs in starting and operating the franchise, including any non-refundable deposits or fees, along with ongoing advertising and marketing fees.
- Training. Describes the training programs you will provide to the franchisee.
- Restrictions. Lists any restrictions on sources of products or services and the suppliers that must be used to maintain the integrity of the franchise system.
- Financing. Discusses any financing help you may provide to the franchisee.
- Obligations. Lists the obligations and expectations of both you and the franchisee in the daily operation of the business.
- Financial performance. This section is optional, and many franchisors choose to omit any information or projections about sales or revenues.
- Financial statements. You must provide information about your financial status, including audited financials so a franchisee can determine if your company is profitable and able to sustain the franchise system and support over time through varying economic conditions.
- Current franchisee contacts. Names and contact information of current franchisees so the prospective franchisee can speak to them and glean more information about the viability of the franchise system, support, and revenue opportunities.
Seek Professional Help
This is not something you can do by yourself. It’s important to work with a franchise attorney and possibly a franchise consultant as you develop your legal documents. Failure to comply with the FTC rules is one of the primary bases for legal claims by franchisees against franchisors. Your long-term income stream is dependent on your ability to sell franchises and maintain good working relationships with your franchisees, so it’s important to get the legal paperwork done correctly the first time out.
It’s also important to keep an arm’s length between the legal advice you get from your attorney and the business or operational advice you may get from a franchise consultant. For example, if your consultant suggests changing the wording in your FDD, be sure to run it by your attorney for legal review.