The Federal Trade Commission (FTC) is responsible for supervising franchise rules and regulations. Their goal is to protect the investments of prospective franchisees. To achieve this, franchisors must create and provide franchisees with a Franchise Disclosure Document (FDD). The Franchise FDD contains 23 specific items, which include an audit of the franchise financial statement. We will discuss this document and each item.
Franchise FDD Explained
A Franchise FDD is designed to provide franchisees with important information about the franchise opportunity. They must be provided to them at least 14 calendar days before signing a binding agreement.
What does the disclosure documents include?
The Franchise FDD includes the franchisor’s background, the franchise system’s history and financial performance, and the franchisor’s and franchisee’s obligations.
The 23 Franchise FDD Items
The 23 items in the document must follow the amended rule (Rule 16 CFR Part 436 and 437) and are shown in this specific order:
Item 1: The Franchisor and any parents, predecessors, and affiliates
Franchisors disclose background information about any parents, predecessors, affiliates, and any business laws that apply to the business.
Item 2: Business experience
Lists information about the franchisor’s management team, such as directors and principal officers, for the last five years.
Item 3: Litigation
Any litigation history is disclosed, including pending lawsuits, franchise relationship lawsuits, and any current government injunctive actions for each person identified in Item 2.
Item 4: Bankruptcy
Disclose the franchisor’s bankruptcy history, affiliates, predecessors, and parents.
Item 5: Initial fees
This item refers to any fees and payments, or commitment to pay, for the services or goods the franchisor will provide to the franchisee and whether it is payable as a lump sum or in installments.
Item 6: Other fees
It includes operation costs or recurring charges, such as royalties, advertising, or transfer fees.
Item 7: Estimated initial investment
Disclose the franchisee’s estimated initial investment for expenses in chart format, including third-party items (e.g., rent, equipment, etc.).
Item 8: Restrictions on the sources of products and services
Includes obligatory purchases, restrictions on service or product sources, and the revenue amount franchisors may receive.
Item 9: Franchisee’s obligations
Franchisee’s obligations are shown in a chart and reference the franchise agreement and any relevant contracts.
Item 10: Financing
Disclose material terms and conditions of the financial arrangements.
Item 11: Franchisor’s assistance, advertising, computer systems, and training
It discloses the franchisor’s obligations to assist franchisees during the franchise operation (e.g., training, store opening assistance, etc.).
Item 12: Territory
Refers to the assigned territories and sales restrictions, if applicable.
Item 13: Trademarks
Disclose any registered trademarks, ongoing applications, or renewals.
Item 14: Patents, copyrights, and proprietary information
Disclose franchise-related intellectual property.
Item 15: Obligation to participate in the actual operation of the franchise business
Disclose whether the franchisee must participate in the day-to-day franchise operation personally.
Item 16: Restrictions on what products the franchisee may sell
It discloses the amount of control over the products the franchisee can sell.
Item 17: Renewal, termination, transfer, and dispute resolution
Summary of the franchise’s basic legal rights and obligations for renewals, terminations, transfers, and dispute resolutions.
Item 18: Public figures
Disclose any public figures who receive payments for promotion and if they form part of the management team.
Item 19: Financial performance representations
Discloses a representation of the history or projected financial performance of the franchise.
Item 20: Outlets and franchise information
Statistical information of franchised and company-owned outlets for the last three years.
Item 21: Financial statements
Disclose audited financial statements from the last three years.
Item 22: Contracts
Attach all contracts and agreements for the franchisee.
Item 23: Receipt
It discloses an acknowledgment receipt the franchisee must return to the franchisor as confirmation that the Franchise FDD was received.
At Assurance Dimensions, we understand the franchisor’s responsibility for Item 21 and can prepare for your next audit of the franchise financial statement. Contact us today to learn how our auditor services can help you with your franchise accounting audit.
