The Difference Between a Franchise Agreement and an FDD
Franchises comprise about 10.5 percent of all businesses in the United States, representing 3 percent of the national gross domestic product (GDP).
Most people associate franchises with quick-service restaurants (QSRs) like McDonald’s or small retail outlets like 7-Eleven, and McDonald’s and 7-Eleven do stand at the top of the franchising list. However, according to the International Franchise Association, franchising covers a wide spectrum, including lodging, real estate, business services, commercial and residential services, full-service restaurants, and much more.
Franchising offers several benefits, including a proven concept and often a brand name that is immediately recognizable, as well as established operating procedures, training, and help with advertising and marketing. These options vary by the type and nature of the franchise, but franchises may give the purchaser a leg up on the competition and an easier entry into a particular market.
If you’re looking to establish or buy a franchise in or around Seattle, Washington, or anywhere throughout the United States, including Oregon, Texas, and Florida, contact Bundy & Fichter PLLC. Franchising has been our focus for more than four decades, and we know the industry very well. We can answer all your questions and help you navigate the franchising regulations and legal standards.
Getting Started: The Franchise Disclosure Document (FDD)
The franchise-regulating body, the Federal Trade Commission, requires that each franchisor create and maintain what is called a franchise disclosure document, or FDD. This is a legal instrument that must be presented to each potential buyer. If you’re looking to franchise your business, you will need to create an FDD, and if you’re looking to buy, you will need to pore through the FDD to see what your franchise future entails.
The FDD is supposed to provide a clear picture of the anticipated business relationship between the franchisee and the franchisor.
A franchise is like a license allowing another party access to the franchisor’s proprietary knowledge, processes, and trademarks. The FDD is the gateway to entering into that relationship and licensing arrangement.
The FDD consists of 23 required sections. The FTC requires that any potential buyer be given 14 days to examine the FDD before any money exchanges hands. Each section of the FDD is important for anyone considering an investment, but some stand out as more important based on what you, as a buyer, are getting into.
Item 2 details the people and their experience who are running the franchise from the top. Section 3 covers ongoing litigation the franchisee may be facing. Lawsuits are not unusual for large franchisors, but they can also alert a buyer to potential challenges.
Item 3– Estimated Initial Investment – can be an eye-opener. You may have been given a stated franchise fee requirement, but Item 7 will cover what your costs actually may be. Item 12 on territory should outline whether you will have a protected territory and its scope, if any.. This section should reveal if other franchisees of the same franchise business are operating close to you.
Item 19 on Financial Performance Representations is designed to portray what you can expect in terms of generating revenue based on the experience of other franchisees, but sometimes the information is incomplete or drawn from a small subset of franchisees to make the information look better. Buyer beware.
Finally, Item 21 on Financial Statements should give you an overview of the franchise’s overall economic health. Again, however, as a buyer, you may want to dig deeper by talking to other franchisees about what’s really going on.
Culminating Step: The Franchise Agreement
The franchise agreement is the legal document that creates and defines the franchise relationship. There is no standard format for a franchise agreement, but it is a legally binding document that sets forth the terms and conditions of becoming a franchisee. It should detail what the franchisor expects from the franchisee in operating the business.
The franchise agreement should include the upfront franchise fee and any ongoing fees for support services such as advertising and marketing. It should also cover royalties that the franchisee is required to pay the franchisor, usually a percentage of monthly sales. The term (number of years) of the agreement should also be clearly specified.
Other items generally covered include the rights and limitations for using any trademarks, the right to renew the agreement, whether you can exit from it, or resell the franchise to someone else, the level of training and support being provided, and more.
Why Legal Guidance and Assistance Are Needed
If you’re a potential franchisor, you must draft and update the FDD. It is not a do-it-yourself project. It is something that is legally mandated and should be taken seriously. You will definitely need the help of an experienced franchise attorney to make sure your FDD complies with all federal and state regulations.
If you’re a potential franchisee, you will need an attorney to review the FDD and advise you of any potential pitfalls or future misunderstandings. Likewise, with the franchise agreement, both franchisor and franchisee will want to ensure their rights and interests are protected in the document, which is legally binding.
Turn to Bundy & Fichter PLLC
With more than four decades of experience in franchising, including in preparing and evaluating FDD's and the franchise agreement, the attorneys at Bundy & Fichter PLLC stand ready to assist you as a franchisor or franchisee in navigating all the requirements and hurdles of a successful business relationship.
Contact us immediately wherever you are in the United States, so we can help you build your franchise operation from either perspective, franchisor or franchisee. Don’t leave anything to chance.