Franchise disclosure documents are an integral part of any franchise transaction and allow the prospective franchisee to better understand exactly what is required in the franchisee-franchisor relationship. Items 9, 11 and 15 cover franchisor and franchisee obligations in detail and taken together they explain the franchisor’s required participation in advertising and training as well as the extent of the franchisor’s duty to participate in daily operations. These issues come with a cross-referencing section that should help a franchisee better understand the costs that come with these requirements. For more on this continue reading the following article from Blue MauMau.
This is the sixth in a series of articles for prospective franchisees that discuss the components of a franchise disclosure document. Unlike almost all other articles about what you will learn in a franchise disclosure document, however, this series will focus on what you may not learn.This focus is intended to help you both refine and expand your due diligence efforts.
Item 9 – Franchisee’s Obligations
Happily, the franchise disclosure document (FDD) is required to be written in "plain English." Unhappily, the FDD is rife with cross references and unwelcome invitations to make an uphill climb a little steeper. This is particularly true with Item 9, which contains not much more than a "further reading" assignment.
What you will learn.
Specifically, Item 9 requires a table that sets forth cross-references to 25 specified contractual obligations of the franchisee that are common in a franchise relationship. The cross-references are to the relevant provisions of
- The franchise agreement
- Other franchise contracts (guarantees, leases, etc.) and
- The franchise disclosure document.
What you will not learn.
Importantly, there is no required "remarks" column or other explanatory notes; a franchisee really only is entitled to a cross-reference table. Accordingly, you must read, preferably with the assistance of a qualified franchise attorney, the cross-referenced sections in the applicable agreements and FDD to make your Item 11 review at all meaningful. Still, the table is valuable because, at a minimum, it may alert you to obligations that you may not have considered to be in your court. For example, the very first item on the table is "Site selection and acquisition/lease." Many prospective franchisees may wrongly assume that the burden of site selection is entirely on the franchisor. In fact, many franchise agreements simply provide site selection criteria and reserve the right to terminate the franchise agreement if the franchisee fails to secure a suitable site within a prescribed time period.
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Item 11 – Franchisor’s Assistance, Advertising, Computer Systems and training
What you will learn.
Item 11, which describes the franchisor’s obligations under the franchise agreement to furnish assistance to the franchisee, generally may not be a quantum leap in specificity from Item 9’s cross-references, but at least you get some verbs. The franchisor is required to disclose pre-opening assistance such as site selection, site lease/purchase negotiation and site approval, as well as continuing assistance such as training and advertising. For training, you will learn
- who pays for it,
- who pays for the travel, lodging and other expenses,
- who may and must attend and,
- very importantly, whether the franchisee or others must complete the training program to the franchisor’s satisfaction.
With respect to advertising, the most important Item 19 disclosures may be whether the franchisor must spend any amount on advertising in the area or territory where the franchisee is located and the details of any franchisee ad councils.
Item 11 also requires the franchisor to disclose whether it obligates the franchisee to buy or use electronic cash registers or computer systems, including, costs, and obligations with respect to on-going maintenance, repair, upgrades or updates. In addition, Item 11 requires the franchisor to disclose the extent to which it will have independent access to the information that will be generated or stored in any electronic cash register or computer system. Finally, Item 11 requires the franchisor to disclose the table of contents of the operating manual, the number of pages devoted to each topic and the total number of pages in the manual (this disclosure may be omitted if the franchisor offers the prospective franchisee the opportunity to view the operating manual before the franchise purchase).
In my view, however, the two most important disclosures in Item 11 are (1) the time limit for the franchisor to locate or approve or disapprove the unit site and the consequences if the franchisor and franchisee cannot agree on a site and (2) the typical length of time between the earlier of the signing of the franchise agreement or the first franchisee payment and the opening of the franchisee’s business. The first is pretty important because a breach of the time limit can result in termination with a complete or partial forfeiture of the franchise fee. The second deserves careful consideration because the initial franchise term may commence upon signing the franchise agreement and the subsequent site selection and build out can erode a decent chunk of that term.
What you will not learn.
You may not learn what you’re not getting. Item 11 requires a boilerplate warning that the franchisor "is not required to provide you with any assistance" except for the assistance that’s specifically listed. So, don’t assume any assistance from the franchisor is forthcoming unless you see it in Item 11. That’s easier said than done, particularly if the franchise development team does what they’re generally wont to do: assure you that the franchisor is your BFF and embellish what it will do. With such (almost always unenforceable) promises, it’s easy to let your guard down and make some costly assumptions.
Item 15 – Obligations to Participate in the Actual Operations of the Franchise Business
What you will learn.
Item 15’s core disclosure is on one level pretty simple: it requires the franchisor to disclose
- the franchisee’s obligation to participate personally in the direct operation of the franchisee’s business,
- whether the franchisor recommends participation
- if personal "on-site" participation is not required,
- whether the franchisor nonetheless recommends it,
- the limits on whom the franchisee can hire as an on-site supervisor,
- the training requirements for that on-site supervisor and,
- if the franchisee is a business entity, any franchise equity interest requirements for that on-site supervisor, and
- any restrictions (e.g., to maintain trade secrets or enter into a covenant not to compete) that the franchisee must place on its manager.
What you will not learn.
Well, I say the Item 15 disclosure requirements are simple because unless you’re buying at least a six-pack (yes, that’s what the franchise development folks call them), the franchisee’s participation obligation has to be personal, direct and full to ensure success. Some sure-to-be disappointed prospective single-unit franchisees are looking for a business to check in on between rounds of golf. But the reality is that unless you have a putting green in your franchise unit, the only links you’ll have time for will be the sausages you’re slicing for that extra-toppings pizza. I’m not trying to be anything other than realistic here. Most people rightly pair success with hard work and that’s no less true for a franchise business.
But the franchisor is not required to tell you exactly how hard you will work. Specifically, the franchisor need not disclose what your operating hours will be or the method used to notify you of changes to the required operating hours. That’s because the Federal Trade Commission does not think this information rises to the "level of materiality." But if the length and predictability of your workday are important to you, get some clarity on this issue from the franchisor or through your franchisee validation efforts.
Mike Sheehan is a franchise consultant and attorney. He is the president of Focus Ventures (www.focusonfranchise.com) and formerly served as a securities attorney and as general counsel for a Fortune 100 financial services company. His Franchise Focus Blog (www.franchisefocus.blogspot.com) focuses on helpful information, tips and current news for prospective franchisees.
This article should not be construed as legal advice or a legal opinion on any specific facts or circumstances. The contents are intended for general information purposes only and you are urged to consult your own franchise attorney concerning your own situation and any specific legal questions you may have.