Franchise Disclosure Document vs. Franchise Agreement

July 28, 2023by Brian Walsh

Because starting a new business, from scratch, on your own, can be an overwhelming prospect many new entrepreneurs find the franchise business model very attractive. Buying a franchised business means you are buying a ready-made business model, with the right systems in place, a proven track record and is backed by an established company with a known brand.

Buying a franchised business sounds great, right? Many of the more difficult aspects of starting a new successful business have already been worked out ahead of time. Unfortunately, not all franchises are created equal, and success is not guaranteed.

Although the vast majority of franchisors work hard to build a successful franchise network, and work hard to be transparent, there are some that are less than scrupulous and try to take advantage of their franchisees and often try to attract new franchisees using dishonest, unfair, and sometimes fraudulent tactics.

It is crucial that you are well-informed on the details of the franchise opportunity you are considering. Franchise Disclosure Documents and Franchise Agreements can provide much-needed information. However, these two documents are often confused with one another.

While these documents contain similar information, they are used for two different purposes.

What is a
Franchise Disclosure Document?

A franchise disclosure document (FDD) is required by the Federal Trade Commission (FTC), and it is a pre-sale document that is intended to disclose all the important information that a prospective franchisee would need to make a well-informed decision about purchasing a franchise business.

In other words, the information found in the FDD lays out the groundwork of the franchise business arrangement.

An FDD gives prospective franchisees a clear idea of what is expected of them, what the franchisor is responsible for, and what they should expect if they agree to enter into a franchise relationship with a particular franchisor.

FDDs can be long, averaging over two hundred pages, and challenging to read. But they are organized into twenty-three sections, called Items. Each Item covers a specific topic.

You should ensure that you’ve read and understood each Item:

  • Item 1: Franchisor’s Background
  • Item 2: Business Background
  • Item 3: Litigation History
  • Item 4: Bankruptcy
  • Item 5: Initial Fees
  • Item 6: Other Fees
  • Item 7: Estimated Initial Investment
  • Item 8: Restrictions on Sources of Products and Services
  • Item 9: Franchisee’s Obligations
  • Item 10 Financing
  • Item 11: Advertising and Training
  • Item 12: Territory
  • Item 13: Trademarks
  • Item 14: Patents, Copyrights, and Proprietary Information
  • Item 15: Obligation to Participate in Actual Operation of the Franchise Business
  • Item 16: Restrictions on What the Franchisee May Sell
  • Item 17: Renewal, Termination, Transfer, and Dispute Resolution
  • Item 18: Public Figures
  • Item 19: Financial Performance Representations
  • Item 20: Outlets and Franchisee Information
  • Item 21: Financial Statements
  • Item 22: Contracts (an example franchise agreement)
  • Item 23: Receipts

All of the most important information about the franchisor and the key features of their business relationship with potential franchisees can be found in an FDD. These documents are thorough and can include hundreds of pages for good reason. Having a detailed franchise disclosure document helps prevent confusion and cuts back on disputes later on in the franchise relationship.

If you are a prospective franchisee, knowing as much as you can about the strategies, growth, mission, expectations, and financial performance of the franchisor helps you make the best decision possible. You will know upfront how much money you will need to invest initially, what royalties the franchisor demands, and the information you need to find out how other franchisees are performing, all of which can provide an accurate snapshot of your potential return on investment.

The information found in the FDD also allows you to create a business plan and perform your due diligence before getting started on this new venture.

The purpose of an FDD is to give both parties the opportunity to fully evaluate the arrangement before investing in the franchise or signing an agreement.

The Federal Trade Commission requires franchisors to give potential franchisees at least 14 days to review their FDD. If you are considering purchasing a franchise business, the franchisor’s FDD can provide valuable insight.

You should take those 14 days to fully review every aspect of the document. It is highly advised that you have a franchise lawyer review the document identifying any red flag issues and potential future problems.

What is a
Franchise Agreement?

Because an example franchise agreement is included as part of the franchise disclosure document it is sometimes confused with the FDD. The FA included in the FDD is not the same as the one you eventually sign if you decide to buy the franchise business.

The Franchise Disclosure Document is intended to disclose all information a prospective franchisee may need to make a well-informed decision about the franchise offering. The franchise agreement is a legally binding contract that, once signed, creates the franchise relationship. Having an example franchise agreement to review prior to closing on the franchise deal allows the prospective franchisee to be well informed about the content of the contract they will be expected to sign. The example contract is the same across the board for all franchisees and is for disclosure purposes only.

Every FDD issued by a franchisor is the same, but each franchise agreement is tailored to the specific prospective franchisee it is made for. This allows franchisors to keep their business operations cohesive and uniform while also changing key details as necessary for different locations or various situations.

Although many of the specifics in a franchise agreement may be different due to negotiations or tailored to specific situations they contain similar terms and provisions.

For instance, it provides targeted information within the context of legal obligations and gives specific details like territory and term length. It also defines and describes the franchisee’s obligations regarding royalties, marketing efforts, and operational region, operating systems, suppliers, and products in this contract.

Another key feature of a franchise agreement involves licensing and trademarks. The franchisor owns the rights to the name, logo, products, design, and every other aspect of the business. The franchise agreement should include details on the franchisee’s right to use these protected features in their day-to-day operations.

Franchise agreements do not just require the franchisee to adhere to certain requirements; there are also elements within the contract that outline the franchisor’s responsibilities. For instance, each franchise agreement will designate a franchisor’s duties involving ongoing support and training for franchisees.

Key Takeaways –
FDDs and Franchise Agreements

To recap, here is a breakdown of the similarities and differences between these two documents.

  • Both an FDD and a franchise agreement give valuable information and insight into a franchise relationship prior to entering into a business deal.
  • Both are required by the FTC – franchisors are required to provide an FDD to potential franchisees, which includes Item 22: Contracts (including the franchise agreement).
  • An FDD is a disclosure document intended to educate the prospective franchisee.
  • A franchise agreement is a legally binding contract that creates the franchise relationship.
  • The FDD contains information about the legal and financial information about the franchisor, history of the system and material facts about the franchise opportunity.
  • The Franchise agreement contains the terms and conditions of the agreement.
  • Every FDD within a franchise is the same.
  • Each franchise agreement can vary based on the specific franchisee involved.
  • A franchisor must give a franchisee at least 14 days to review an FDD.
  • A business relationship is established only after both parties sign the franchise agreement.

The Franchise Disclosure Document and the Franchise Agreement have similar information but are used for distinctly different purposes.

Have an experienced franchise lawyer review both documents to look for red flags and inconsistencies. They will be able to explain every aspect of both the Franchise disclosure document and the Franchise Agreement. If you are confused about any Item, clause or term they will be able to fully clary the matter.

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