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During the pre-sale process, a franchisor must provide a potential buyer with certain information about the franchise system and agreement. By law, they must do this in a franchise disclosure document (FDD).
There are strict requirements for what a franchisor needs to include in an FDD, as well as how it’s formatted.
It’s essential that franchisors have a clear understanding of these requirements so their FDDs are complete and accurate.
Otherwise, their franchise agreement may be delayed or even derailed.
To help you out, this article takes a closer look at what an FDD is and provides an overview of the 23 main items to include in one.
- A franchise disclosure agreement (FDD) outlines the key details of a proposed franchise agreement to help a franchisee decide whether to invest in a franchise.
- FDDs explain what the franchisor and franchisee must do, disclose the franchise’s financial situation, and set out other important information about the agreement.
- By law, a franchisor must give a franchisee an FDD at least 14 days before the franchisee signs an agreement or pays any money to the franchisor.
- The Franchise Rule sets out what a franchisor must include in an FDD. This includes 23 mandatory disclosure items—like the franchisee’s initial fees, the franchisee’s territory, and the franchise’s trademarks.
- FDDs are complex legal documents and it’s important to get them right to ensure the successful sale or purchase of a franchise. For this reason, you should speak to a lawyer when preparing or reviewing an FDD.
What Is an FDD?
An FDD is a document US franchisors must prepare and give to prospective franchisees during the pre-sale process. A franchisor is an individual or company that owns the franchise system. A franchisee is an individual or company that buys a franchise business from the franchisor.
The document must address 23 specific items about the proposed franchise agreement, including the franchise system’s background and financial information and the franchisor and franchisee’s legal obligations.
Franchisors must provide franchisees with an FDD at least 14 days before they sign a franchise agreement or the franchisee pays any money to the franchisor.
FDDs are required and regulated by the Federal Trade Commission’s (FTC) Franchise Rule.
🧠 Did You Know?
The Federal Trade Commission is a federal consumer protection agency in the US. It regulates business activities—including franchises—to ensure they remain fair and to prevent any fraud or deception.
What is the purpose of an FDD?
FDDs ensure franchisors provide franchisees with the necessary information to help them decide whether to buy a franchise. It sets out important details about the relationship between the franchisor and franchisee, as well as how the franchise agreement will work.
An FDD helps the franchisee do their due diligence and make an informed decision about buying a franchise by weighing up its strengths, weaknesses, and potential risks.
What to Include in an FDD
The FTC’s Franchise Rule outlines what information an FDD must include and how it should be formatted.
An FDD must include a cover page, a table of contents, 23 specific items relating to the franchise agreement, and various attachments like leases and confidentiality agreements.
Additionally, the Franchise Rule requires certain statements to be included word-for-word in some sections of the FDD. For example, if other franchisees can open a franchise business in the same territory, the FDD must state:
“You will not receive an exclusive territory. You may face competition from other franchisees, from outlets that we own, or from other channels of distribution or competitive brands that we control.”
The Franchise Rule also sets out specific formatting requirements for each section. For example, some information must be presented in table format and certain words must be in bold type.
23 items to include in an FDD
Franchisor, and any Parents, Predecessors, and Affiliates
In this section, the franchisor must provide information on the background and corporate structure of the franchise system. This includes any:
- Parent (a person or entity that controls the franchise).
- Predecessor (a person or entity that the franchisor acquired most of their assets from).
- Affiliate (another person or entity controlled by the franchisor or by the same parent as the franchisor).
A franchisor must also state what type of business operation the franchise system is—for example, a corporation, partnership, or limited liability company (LLC).
🧠 Did You Know?
In 2020, there were an estimated 790,500 franchise businesses in the US. These franchises generated roughly $825 billion that year.
While franchising is common in the fast food and retail sectors, it’s also used in the real estate, personal services, and commercial services industries.
The franchisor must detail the names and previous business experience of the individuals on the franchise system’s management team. This includes directors, trustees, general partners, principal officers, and people with management responsibilities for the sale or operation of the franchise.
This section describes any current or previous legal actions against the franchisor, a parent, predecessor, certain affiliates, or a member of the franchisor’s management team.
The franchisor must provide details of these legal actions including their title and case number, as well as a summary of the proceedings.
This helps the franchisee assess any legal risks associated with the franchise.
A franchisor must disclose whether the franchisor, a parent, predecessor, affiliate, or any member of its management team declared bankruptcy in the last 10 years.
Among other details, this section must include a summary of the bankruptcy proceedings. This helps the franchisee to understand the financial background of the franchise.
The FDD must set out the fees the franchisee needs to pay before they can open the franchise. This is often a flat fee but can include other charges such as training or initial inventory fees.
This section must address any other fees the franchisee must pay the franchisor to run the franchise, like royalties, advertising, renewal, or transfer fees. This also includes any fees collected by the franchisor to pay third parties—for example, software licensing fees.
These fees need to be set out in a table that details the fee type, amount, due date, and any remarks.
Estimated initial investment
The franchisor must provide an estimate of the set-up and opening costs that a franchisee will incur. Expenditure varies based on the nature of the franchise business. They may include costs like the initial franchise fee, equipment and inventory costs, insurance, and training expenses.
This section must include the following details in table format: the type of expenditure, amount, payment method, due date, and who receives the payment.
Restrictions on sources of products and services
If there are any restrictions on where a franchisee can buy or lease goods or services for the franchise business, this must be set out in the FDD.
For example, the franchisor may require the franchisee to use only certain suppliers like the franchisor, its affiliates, or another approved supplier for items such as equipment, software, or inventory. Franchisors do this to ensure the product or service remains consistent across all franchise businesses.
The information in this section needs to state, among other details, whether the franchisor or its officers may benefit from these restrictions.
This section details the franchisee’s obligations under the franchise agreement. It can address topics like fees, training, compliance, insurance, and advertising.
These obligations must be set out in a reference table listing the obligation and the relevant section of the FDD and franchise agreement. This helps the franchisee easily locate and understand their obligations as laid out in the FDD.
The franchisor must clearly state whether they’re offering the franchisee financing arrangements like leases or installment contracts.
If a franchisor does offer financing, this section must detail the terms and conditions, including the description, amount, and interest rate.
Franchisor’s assistance, advertising, computer systems, and training
In this section, the franchisor needs to note its obligations to the franchisee in terms of assistance, advertising, computer systems, and training. Assistance includes a franchisor’s pre-opening obligations, such as fitting out a business location, and ongoing obligations like employee training. The specific details required depend on the type of assistance offered.
This section must describe the type of assistance and refer to the relevant section of the franchise agreement where more details can be found.
This is a very important section of the FDD. If a franchisor’s obligations aren’t described here, they don’t have to provide specific assistance to the franchisee. .
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This section specifies the location and territory of the franchise business, including whether it’s an exclusive territory. It also describes the franchisee and franchisor’s rights concerning the territory.
A territory is an area the franchise business operates in—for example, based on a certain radius or zip code. If a franchisee is granted an exclusive territory, other franchisees can’t open a franchise business there.
If the franchisor intends to open a competing franchise in the territory, they must say so in this section.
A franchisor must detail the franchise’s trademarks, including their registration details with the US Patent and Trademark Office. They also need to note the franchisee’s rights and restrictions on using these trademarks. This includes any pending legal actions that may affect the use of the trademark.
Additionally, this section needs to address the franchisor’s obligations around protecting the franchisee against legal claims regarding their use of the trademark.
This information helps a franchisee understand the trademark’s value and whether it’s legally protected.
Patents, copyrights, and proprietary information
This section details a franchisee’s rights in relation to the franchise system’s intellectual property. This includes any patents, patent applications, or copyright material.
The franchisor must also provide the details of any legal proceedings or other factors that may affect a franchisee’s ability to use the intellectual property. They need to generally describe any confidential information or trade secrets the franchise owns, too.
Obligation to participate in the actual operation of the franchise business
This section explains how much time a franchisee needs to spend running the franchise business each day, including any requirement to personally participate in the operation of the franchise.
In this section, a franchisor should also list any limitations that a franchisee must put on a manager, such as confidentiality, non-disclosure, or non-compete agreements.
Restrictions on what the franchisee may sell
The franchisor must explain any limits on what goods and services the franchisee can sell under the franchise business. For example, a franchisee may only be able to sell goods or services approved by the franchisor.
This section also explains whether the agreement limits the franchisee’s access to customers. For example, a franchisor may prevent a franchisee from selling to customers in a certain location to protect another franchisee’s exclusive territory.
Renewal, termination, transfer, and dispute resolution
In this section, the franchisor must provide a summary table of the terms relating to the renewal, termination, and transfer of the franchise agreement, with reference to the relevant section(s) of the agreement.
This section must also summarize the process for resolving any disputes between the parties.
If any public figures like athletes or actors promote, recommend, or endorse the franchise system, it must be disclosed in this section. The franchisor must explain the nature of their involvement and the compensation they receive for it.
If there are no public figures involved, this must be expressly stated.
This section applies only if the public figure’s involvement helps sell the franchise system to franchisees, not goods or services to the public.
Financial performance representations
A financial performance representation is where a franchisor makes a claim about a franchise business’s actual or predicted performance in terms of income, sales, or profits.
If a franchisor has made this representation, they must include it in the FDD and provide information about how they predicted these figures. Required details depend on whether the representation is of the business’s past or predicted future performance.
Outlets and franchisee information
A franchisor must provide information on the number of businesses franchised in the previous 3 years, including details on any location changes and business closures.
This can help the franchisee assess whether the business is a good investment.
To help a franchisee understand the franchise’s financial position, a franchisor must provide various independently audited financial statements, including:
- Balance sheets for the previous 2 years.
- Operations, shareholders equity, and cash flow statements for the previous 3 years.
- Separate financial statements for any sub-franchisor.
- Separate financial statements for any parent that promises to fulfill post-sale obligations for the franchisor or that guarantees the franchisor’s obligations.
In some situations, a franchisor may be able to include an affiliate’s financial statements in place of its own. Certain start-up franchisors can provide unaudited statements in their first year of operation.
The FDD must have attached to it a copy of any contract the franchisee has to sign before opening the franchise business. This includes the franchise agreement as well as contracts related to financing, purchasing, confidentiality agreements, and real estate.
This section confirms that the franchisee received the FDD within the required 14-day time period. It provides a space for the franchisee to sign and date the document.
The FDD must include 2 copies of this section. One stays attached to the FDD, and the other is returned to the franchisor as proof of receipt.
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Getting Help with an FDD
FDDs are detailed, complex documents, so it’s important to get professional help when preparing or considering one.
As a starting point, the FTC provides information on FDDs and their requirements, including a Compliance Guide.
It’s also essential you seek legal advice. FDDs must contain specific information presented in a certain way.
If you’re a franchisor, a lawyer can help you draft a complete and correct FDD. They can write it in easy-to-understand language to ensure the franchisee fully understands the proposed agreement.
If you’re a franchisee, you should also get independent legal advice on the FDD you’re considering. Entering into a franchise agreement is a risk, just like any other investment opportunity. A lawyer can help you properly understand your rights and obligations under a proposed franchise agreement and answer any questions.
In addition to FTC requirements, several US states regulate the franchise sale process. For example, in some states, the FDD must be registered either once or every year (with an extra filing fee). Make sure you check the requirements in your state to ensure you comply with your obligations.
- Find a local lawyer who specializes in franchise law or speak to your in-house legal team for advice when preparing or reviewing an FDD.
- It’s also worth getting an accountant or other financial advisor to review the FDD’s financial statements.
FDDs: The Key to a Successful Franchise Relationship
If you’re involved in the sale of a franchise—either as a franchisor or franchisee—it’s essential you understand the requirements of an FDD. This document presents key information about the franchise system, outlines the franchise relationship, and helps a potential franchisee make an informed decision about their purchase.
The FTC’s Franchise Rule dictates the contents and format of an FDD. By seeking expert legal and financial guidance, you can confidently navigate these complex requirements and a successful sale of a franchise business.
The information presented on this website about franchise disclosure documents in the United States is intended to be accurate and informative. However, laws and regulations can change and may vary depending on individual circumstances. While we have made every effort to ensure the information provided is up-to-date and reliable, we cannot guarantee its completeness or accuracy. Therefore, we strongly recommend that readers seek guidance from their legal department or a qualified attorney to ensure compliance with applicable laws and regulations. Please note that we cannot be held liable for any actions taken or not taken based on the information presented on this website.