Franchise
- (#1) The Franchisor, Its Predecessors and Affiliates
- (#2) Business Experience
- (#3) Litigation
- (#4) Bankruptcy
- (#5) Initial Franchise Fee
- (#6) Other Fees
- (#7) Initial Investment
- (#8) Restrictions on Sources of Products and Services
- (#9) Franchisee’s Obligations
- (#10) Financing
- (#11) Franchisor’s Obligations
- (#12) Territory
- (#13) Trademarks
- (#14) Patents, Copyrights and Proprietary Information
- (#15) Obligation to Participate in the Actual Operation of the Franchise
- (#16) Restrictions on What the Franchisee May Sell
- (#17) Renewal, Termination, Transfer and Dispute Resolution
- (#18) Public Figures
- (#19) Earnings Claims
- (#20) List of Outlets
- (#21) Financial statements
- (#22) Contracts
- (#23) Receipt
Franchise law requires that a franchisor provide a copy of the disclosure document to each prospective buyer at the earlier of either:
(1) the first personal face-to-face meeting, or
(2) 10 business days prior to the contract signing or payment of monies relating to the franchise relationship.
Although the Federal Trade Commission (FTC) requires franchisors to provide each franchisee with a franchise disclosure document, it is important to note that the FTC does not actually review the content of the UFOC franchisors submit to franchisees. It is up to the prospective franchisee, and his or her attorney and accountant, to check the veracity of the information provided.
Overview of the UFOC
The FTC Franchise Rule, formally titled “Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures,” was the predecessor to the UFOC. Taking effect in October of 1979, it was designed to protect potential franchisees in their franchise investments by providing them with essential and relevant disclosures about the franchise opportunity; thus, making the franchise investment a fully informed decision. This was the first regulation of franchising at the Federal level.
Fourteen years after the Franchise Rule took effect — in April of 1993 — the North American Securities Administrators Association (NASAA) adopted the UFOC Guidelines as the recommended format for franchise disclosure documents at the state level. In December of 1993, the FTC approved the use of the UFOC format as an alternative to that of the FTC’s Franchise Rule. Since then, most franchisors have chosen the UFOC format; one reason being that a number of states do not accept the Franchise Rule format for franchise disclosure.
The Franchise Rule can be found at: http://www.ftc.gov/bcp/franchise/16cfr436.htm, and guidelines for preparing UFOC disclosures are available at: http://www.nasaa.org/content/Files/
UniformFranchiseOfferingCircular.doc.
Careful Consideration of the UFOC
The UFOC is helpful to prospective franchisees and it important to carefully review and understand it before buying a franchise. Depending on the individual franchisor, the length of the UFOC varies from about 75 to 200 pages long. However, all UFOCs are required by law to contain 23 key items. Franchise disclosure documents must also be written in “plain English.”
Remember, although the size of the document can seem overwhelming, don’t make the mistake of allowing this wealth of information to go unexamined or unchecked.
The 23 UFOC Items
(#1) The Franchisor, Its Predecessors and Affiliates
Information about the franchisor, any predecessors and its affiliates. Disclosure includes: a description of the business of the franchisor; previous business experience of the franchisor, its predecessors and affiliates; the business to be operated by the franchisees; and the general market for products or services offered by franchisees.
Keep in mind that investing in a brand new or inexperienced franchisor may be a greater risk than investing in a long-established and successful franchise.
(#2) Business Experience
Information about the past five years’ work experience of all executives of the franchise system (i.e., officers, trustees, directors, and managers) including their main occupations and past employers.
Consider the executives’ experience in managing a franchise system as well as their business experience. Also consider how long these individuals have been with the franchise.
(#3) Litigation
Disclosure of prior (up to 10 years) or present litigation. This includes the franchisor and anyone affiliated with it; i.e., predecessors, executives and franchise brokers
If you do find a number of actions, particularly if franchisees have sued the franchise, be sure to bring to your attorney’s attention for investigation.
(#4) Bankruptcy
Disclosure of any bankruptcy that has occurred within the past ten years involving the franchise, its affiliates or predecessors.
Knowledge of any bankruptcy issues will assist in your assessment of the franchisor’s financial stability and strength. You’ll want to invest in a franchise that will be financially sound and able to deliver the contracted support services.
(#5) Initial Franchise Fee
Information on all initial fees to the franchisor including the initial franchise fee.
Be aware that certain initial fees may be non-refundable.
(#6) Other Fees
Information on other fees that are paid to the franchisor; i.e., ongoing royalty payments and advertising fees.
Franchisees are sometimes unhappy when they find out how their advertising fees will be spent by the franchisor. Since you often must contribute a percentage of your business income to advertising, find out just how and on what these funds will be used. You’ll want to be sure your franchise and territory will benefit.
(#7) Initial Investment
Now in a useful chart format, this disclosure summarizes the franchisor’s estimate of the typical investment costs of establishing a new franchise in their system.
This key information is enormously helpful to you and your accountant in preparing your business plan or obtaining financing. Be sure to note that this is an estimate of typical investment costs; there may be other undisclosed costs.
The Federal Trade Commission suggests that prospective franchisees look for the following checklist items when reviewing the franchisor’s investment costs: continuing royalty payments; advertising payments, both to local and national advertising funds; grand opening or other initial business promotion; business or operating licenses; product or service supply costs; real estate and leasehold improvements; discretionary equipment, such as a computer system or business alarm system; training; legal fees; financial and accounting advice; insurance; compliance with local ordinances such as zoning, waste removal and fire and other safety codes; health insurance; and employee salaries and benefits. Also factor in up to two years of personal living expenses as it may take several months or longer for your business to start making a profit.
Talk to current franchisees and compare your estimates with their actual initial costs. Also speak with franchisees of competing franchise systems; you may be able to get a better deal with a competing franchisor.
(#8) Restrictions on Sources of Products and Services
This item lets you know if you are required to buy or lease products or services from the franchisor or other designated authorized suppliers, and provides details of the specific restrictions imposed.
Supply arrangements are a key aspect of running a successful franchise, so review this section carefully. If it looks like a significant portion of the franchisor’s revenue comes from franchisee purchases, find out from current franchisees if products are priced fairly and efficiently delivered. You don’t want a situation where the franchisor’s unfair profit is your unfortunate loss.
In optimal circumstances, the combined purchasing power of a franchise system can lead to significant savings. On the other hand, understand that these restrictions may limit your ability to cost-effectively operate your outlet.
(#9) Franchisee’s Obligations
This item lists in chart format the franchisee’s obligations in 24 different categories: These categories include: site selection and acquisition, initial training, opening, compliance with system standards, territorial development, insurance, records and reports, and dispute resolution.
This item is simply a cross-reference chart showing where each franchisee obligation is addressed in the narrative items and the franchise agreement.
(#10) Financing
Describes and details any financing offered to the franchisee by the franchisor or affiliated third party.
A small number of sophisticated franchisors do offer in-house financing. A larger percentage have special arrangements for franchisee financing with particular banks or other lending institutions.
(#11) Franchisor’s Obligations
Typically the longest and most illuminating section of the UFOC, it describes in “plain English” the franchisor’s principal obligations under the franchise agreement. This includes a list of (1) services the franchisor is obligated to provide before the opening of the franchisee’s business and (2) the services the franchisor is obligated to provide after the opening. The remainder of this item includes detailed information on the franchisor’s advertising program, any required computer system or electronic cash registers, the operations manual, site selection criteria and procedures, and the franchisor’s training and assistance program.
It will be apparent as you read this item if the franchisor is short or long on contractual obligations.
Keep in mind that a key reason for investing in a franchise is the training and assistance provided. If you suspect the training is insufficient for your needs, you may want to consider another franchise opportunity.
(#12) Territory
This section lays out your territorial rights and restrictions. It includes disclosure on exclusive territory granted, whether or not the franchisor can open another franchise within your geographical area, conditions for relocating the franchise, and any sales quotas imposed on franchisees.
The territorial descriptions in this item can be complicated and too often misunderstood. Read it carefully and be sure to go over with your attorney. Be sure to understand what rights you have both inside and outside of any designated territory.
It is important to note that even the best territorial rights within a franchise system won’t completely prevent competition in your territory. For example, a competing franchise concept could very well open up its doors of business right across the street.
(#13) Trademarks
Discloses information on who owns the trademarks of the franchise, how each trademark is protected, and how the franchisee will be allowed to use the trademarks.
For each trademark, find out if it is federally registered or if registration is still pending. Any trademarks listed by the franchisor should be registered to insure your right to continue using them in the future.
(#14) Patents, Copyrights and Proprietary Information
The franchisor must disclose in this section information about any patents, copyrights, confidential information, or trade secrets relating to the franchise.
Be sure to take the protection of intellectual property seriously. As a franchisee, you must do you part in ensuring that you do not violate any trusts placed in you; i.e., divulging trade secrets or confidential information could have dire consequences.
(#15) Obligation to Participate in the Actual Operation of the Franchise
Information on whether or not the franchisee is required to personally participate in the operation of the franchise.
If the franchisee is not required to personally participate in the business operation, be sure the review the information on the on-site manager. This should include training requirements and any restrictions the franchisee must place on its manager.
(#16) Restrictions on What the Franchisee May Sell
Describes the product line, and discloses any restrictions for other products or services you may be allowed to offer your customers
This type of control can diminish your abilitiy to exercise your own business judgment; i.e., as a restaurant franchise owner, you may not be able to delete menu items that are unpopular or add items you feel would be popular.
(#17) Renewal, Termination, Transfer and Dispute Resolution
Disclosure of the required conditions for renewal, termination, and transfer of the franchise. Also provides information on the approved methods for resolving conflicts and disputes with the franchisor.
Now in a useful format, this chart cross-references and summarizes provisions of the franchise agreement on these topics.
(#18) Public Figures
If a franchisor uses a public figure for endorsing the franchise, or uses a famous person in the franchise’s name or logo, it must disclose information on the compensation paid to the public figure, the amount of the public figure’s investment in the franchise, and the public figure’s involvement in the management of the franchisor.
(#19) Earnings Claims
The FTC does not require franchisors to provide earnings claims to franchisees. If a franchisor chooses to do so, there are strict rules as to the information provided in earnings claims. Because of this, only about 25% of franchisors include them.
If this information is provided, read it carefully and share this information with your accountant for a clearer understanding. If the information is not provided, try to find out why. It may in fact be because the actual earnings of franchisees is less than desirable. Whether or not the franchisor provides earnings information, be sure to query franchisees in the system about their sales and profits.
(#20) List of Outlets
In this item, the franchisor must disclose information on: the number of franchise units; name, address and telephone numbers of all franchisees (up to 100); number of new franchises predicted for the upcoming year; and information and contact information on franchisees who have ceased to be franchisees.
The information provided covers from three years back to projections to one year ahead. This should give you a sense of the direction of the franchise. Again, talk to as many current franchisees as you can. A large and quick expansion of a franchise in terms of number of outlets is not always the best for franchisees; i.e., support services may suffer.
(#21) Financial statements
Financial statements audited by an independent CPA must be provided. They include: (1) for the last three fiscal years — cash flow statements, statements of operations, and statements of stockholders’ equity; and (2) for the last two fiscal years — balance sheets.
These statements can be difficult to understand, so it is critically important to have your accountant review and evaluate these financial statements in order to ascertain the financial strength or weakness of the franchisor.
(#22) Contracts
This section provides copies of all contracts franchisees will be expected to sign if they choose to buy the franchise.
These are not required to be in plain English and may be difficult to understand. Have a qualified franchise attorney review them with you.
(#23) Receipt
An acknowledgement of receipt of the UFOC.
Attached Exhibits
The UFOC includes a number of attached exhibits. They include:
- Franchisor’s audited financial statements
- A copy of each form and contract you will sign if you buy the franchise: franchise agreement, receipt form and other applicable forms (i.e., confidentiality agreements, non-competition agreements and software licenses)
- For multi-state offerings: a list of franchise regulators in each state; a list of franchisor’s agents in each state; and other state-specific supplements required to conform the UFOC to applicable state law.
Last Modified: December 5th, 2009