Everyone knows prospective franchisees should do their due diligence before signing a franchise agreement. But, emerging franchisors also must perform due diligence as they enter the franchising industry or make plans to grow. This includes knowing how to avoid legal pitfalls by being aware of federal and state regulations in the industry.
One of most significant regulations franchisors must be sure to comply with pertains to the sale of franchises – the writing and distribution of the brand’s Franchise Disclosure Document (FDD). The Federal Trade Commission (FTC) mandates that franchisors provide prospective franchisees with an FDD, allowing them to weigh the risks and benefits of investing in the franchise.
Getting the FDD Right
A franchise consulting firm that provides legal advice can help emerging franchisors navigate a number of legal issues. That includes providing assistance with drafting their FDD to be compliant within regulation guidelines. FDD's must contain 23 items of disclosure in a specific format to be compliant. Those 23 items pertain to:
- The franchisor
- Business experience
- Initial fees
- Other fees
- Initial investment
- Restriction on sources of products and services
- Franchisee’s obligations
- Franchisor’s Assistance, Advertising, Computer Systems and Training
- Patents, copyrights and proprietary information
- Obligation to participate in the actual operation of the franchise business
- Restrictions on what the franchisee may sell
- Renewal, termination, transfer, and dispute resolution
- Public Figures
- Financial Performance Representations
- Outlets and Franchisee Information
- Financial statements
There are rules to sharing the FDD with prospective franchisee, too. They include:
- Presenting the FDD to all prospective franchisees at least 14 days prior to the sale of the franchise (this does not include the day you sent the FDD via mail or email or the day on which the Franchise Agreement is signed)
- Providing the prospective candidate with a completed franchise agreement at least seven days prior to the sale of a franchise (this can be concurrent with the FDD 14 day rule)
- Limiting what you share with franchise candidates to only what you disclose in your FDD (including financial performance representations)
- Using “plain English” in your FDD
- Maintaining the FDD as a single document (you cannot distribute it as multiple documents on a thumb drive or disc)
- Following the guidance on all 23 disclosure items, including the cover page and table of contents format
- Not including any other information or materials with the FDD, including promotional items or sales literature
Most franchisors get into trouble when they are more worried about awarding a franchise than breaking the law. This usually results in litigation and the long-term destruction of the brand.
Good Relationships and Franchise Agreements Help
From time to time, a franchisee will sue his or her franchisor, usually surrounding lack of support claims or earnings claims prior to signing the agreement. However, there are steps the franchisor can take to prevent these types of claims from happening or at least to keep litigation from going too far.
- Form sound relationships with your franchisees. You can do this through clear, honest communication. Let them know you are as concerned about their profitability as you are about your own – and mean it. Make sure your franchise development team is being honest and not sharing more than what’s in the FDD.
- Make sure the franchise agreement is air tight. A good franchise agreement, that the franchisee signs, limits the liability of the franchisor. Franchise consultants can help franchisors draft franchise agreements that go a long way toward protecting both the franchisor and the franchisee by making transparent, clear and concise statements of fact in the FDD.
Legal Hassles on the Horizon
In addition to the federal and state compliance and regulatory issues, there are several more operational and small-business issues on the horizon that may impact a franchisor’s business. The regulatory climate of the National Labor Relations Board must be considered as it weighs in and rules on important issues that affect small businesses in America. This includes the joint-employer standard, whereby the employee of the franchisee could be construed to be the employee of the franchisor if it is determined that the franchisor controls, directs and manages the employee to a large degree.
Regardless, franchise consultants can help emerging franchisors avoid most legal hassles by reviewing the FTC Franchise Rule in detail with the franchisor and its team, by watching and listening to the current sales process from initial inquiry through Discovery Day, and by helping the franchisor put in place best practices so they stay disciplined to the proper process that keeps them out of trouble.
Winmark Franchise Partners, with 30 years of franchise experience and more than 800 franchise owners representing more than 1,200 locations for five brands, can help you avoid legal pitfalls. For more information, contact us here or at (844) 452-4600.