Finding Value in a Franchisor’s Mandatory Disclosures Opportunity World & Money ‘N Profits

Published April 2009

By: David L. Cahn and Jeffrey S. Fabian

All franchisors are required by law to provide certain explicit disclosures to prospective franchisees in the form of a uniform Franchise Disclosure Document (the “FDD”). Several of these mandatory disclosures concern the franchisor’s commitments to help you operate the business, including the franchisor’s training and support obligations, advertising services and requirements, and its operations manual. These are key components of the franchise offering, and it is critical for prospective franchisees to gain as much information about these matters as possible.

Beyond merely reviewing the franchisor’s FDD, prospective franchisees should look to the following resources for additional information. First, prospective franchisees should actively question the franchisor’s representatives regarding these topics. These individuals should be more than willing to address your concerns. Second, talk with both current and former franchisees. With a possible exception for franchisees operating in your local area, these individuals are often willing to provide candid perspectives on the franchisor’s operations system. Finally, to the extent possible, prospective franchisees should compare the franchise they are considering with the franchise offerings of companies in the same or similar industries. With these sources of information in mind, an evaluation of the operational aspects described above can provide meaningful insight into the value of a franchise system.

Initial and Ongoing Training

Franchisors are required to disclose the location, duration, fees, costs of attendance, and permitted and mandatory attendees for their initial training program. Regarding ongoing training programs, franchisors must disclose whether the programs are optional or mandatory, the frequency and duration of each program, attendance fees, and the anticipated costs of attendance.

In determining the value to be derived from the franchisor’s training programs, prospective franchisees should consider the coverage of the programs in light of their own relevant experience and the industry involved. Another important consideration is whether the franchisor provides any ongoing training at all. In developing and niche industries, technologies and best practices may be evolving constantly, and you will want to see that the franchisor is taking an active role in maintaining the relevance of its brand. Also, consider how far away from your location the training programs will be held, and whether it will be practical for you to attend.

Other Initial and Ongoing Support
Franchisors must disclose the full extent of the pre- and post-opening support to be provided to franchisees in Item 11 of the FDD. Services included here may relate to site selection, lease negotiation, hiring and training employees, customer referrals through the Internet and/or a toll free telephone system, compliance with special industry laws, and ongoing operations supervision and guidance. For example, how often the franchisor’s representatives typically visit a new franchise during its first year of operation?

There are no specific requirements regarding these disclosures. In other words, it is up to the franchisor to determine what support services they will provide. Therefore, this is one area where comparisons to competing franchises can be particularly useful. Prospective franchisees also should speak to the franchisor and current and former franchisees concerning the scope of services provided, and consider this information with reference to their own particular traits and skill set.

The Operations Manual

Franchisors are required to either disclose the table of contents and total number of pages in their Operations Manual in the FDD, or else make their Operations Manual available for review by a prospective franchisees before purchasing the franchise.

Even when the table of contents is provided, it is a good idea for prospective franchisees to seek to review the Operations Manual in full before signing the franchise agreement. Franchise agreements typically provide that the provisions in the Operations Manual are binding on the franchisee. Therefore, only by reviewing the Operations Manual can a prospective franchisee fully understand the true scope and nature of their potential obligations. Discovery Day is typically a good time to seek permission to review the Operations Manual.

Generally, prospective franchisees will want to see that the Operations Manual provides principles, goals, and general guidelines, as opposed to mandatory step-by-step instructions for every aspect of the management of the franchise. A few areas where the franchisor should provide its franchisees with more specific operational requirements are health and safety compliance and human resources. .

Prospective franchisees should also seek to find out how recently the manual has been updated, and how often updates typically are issued. While a moderate amount of updating is a sign of strength, you do not want to be subject to continually adjusting operating standards.

Advertising Programs

Franchisors are required to inform prospective franchisees of how the franchisor will assist them in the advertisement and promotion of the business. The franchisor also must disclose all mandatory advertising expenses, including system-wide marketing fund contributions, and grand opening and local advertising requirements. If the franchisor has an advertising fund, it also must disclose how contributions were spent during the past year and also what they may be used for in the future.

Prospective franchisees need to consider whether they are likely to benefit from their contributions to the franchisor’s advertising fund, as franchisees typically are not promised any level of benefit from their contributions. For newer franchise systems, prospective franchisees should consider their proposed location in relation to concentrations of franchises and franchisor-owned outlets in other geographic areas. Prospective franchisees should consider the amount of the required contribution in light of the total number of existing outlets that are contributing. Are total funds to be paid in be substantial enough to make the program worthwhile? For larger franchise systems, does the advertising actually succeed in generating profitable business for the existing franchisees?

Finally, prospective franchisees should be sure to understand their rights and restrictions regarding Internet advertising.

Conclusion

Operational standards are a critical component of any franchise system that deserve a thorough analysis during the investigation of any proposed franchise venture. With information from the franchisor’s representatives, current and former franchisees, and competing brands, prospective franchisees can better understand these aspects of a franchise offering, and increase their confidence in deciding whether to pursue a particular franchise opportunity.
David L. Cahn is counsel at Whiteford, Taylor, Preston. Jeffrey Fabian is a former associate of David’s. David can be reached at 410-347-9442