Understanding Franchise Disclosure Documents (FDD)

Introduction

If you want to invest in a franchise in the UK, it’s important to understand the franchise disclosure documents. They should provide all the information about the franchise opportunity you need to make an informed decision about whether to invest.

In this article, we’ll take a look at what you need to look out for when you receive franchise disclosure documents in the UK.

The BFA Code of Ethics and Franchise Disclosure Obligations

• The British Franchise Association (BFA) is not in charge of regulating the franchise business in the UK.
• As the main group for franchise businesses in the UK, the BFA produced a Code of Ethics that all its members who want to maintain their accreditation must follow.
• A franchisor doesn’t have to be a member to franchise his or her business. Adhering to the Code of Ethics regardless, demonstrates that their business operates with integrity and honesty.
• Franchisors who fail to adhere to the disclosure standards set by the BFA are at higher risk of facing legal action, regardless of whether they have any plans to become a member of the organization.
• The Code says that franchisors must tell investors certain things when they sell franchises.

What is a Franchise Disclosure Document (FDD)?

• Franchise disclosure documents are a set of documents that franchisors should ethically disclose to potential franchisees before they sign the franchise agreement.
• These documents provide in-depth information regarding the franchise business’s financial performance, litigation history, and the background of the franchisor in the business.
• In the UK, this collection of documents is known as the “Franchise Disclosure Document” (FDD). It is designed to provide franchisees with all the necessary information to make an informed decision about investing in a franchise.

What Information Should the Franchise Disclosure Document Contain?

The UK is one of the few places in the world where there are no laws about franchise disclosure. However, the BFA Code of Ethics requires franchisors to provide certain information so prospective franchisees can sign a legally binding contract with “full knowledge.”

First, they must give prospective franchisees a copy of the BFA Code of Ethics. In reality, only a small number of UK-based franchisors follow this rule. This isn’t because they don’t like it; they just don’t know about it.

Then, before signing the franchise agreement, they have to give:

“full and accurate written disclosure of all information, material to the franchise relationship, within a reasonable time prior to executing the agreement.”

In America, the contents of the FDD are regulated by federal and state franchise laws. Franchisors must disclose 23 items, which is far more strict than what is ethically required in the UK.

The BFA has stated what information in the FDD counts as full and accurate disclosure in the UK:

• The franchisor‘s business and financial situation
• The people who are part of the franchise business
• The franchise proposition
• The franchisees
• The financial forecasts
• The Franchise Agreement

We’ll talk about each of these in turn below:

The Business and Financial Position of the Franchisor

So the franchisor‘s business history and experience can be judged, the franchisor should “tell the story” of the business, including how it has evolved over how long.

The franchisor’s most recent audited financial statements, including certified balance sheets and profit and loss records, should be provided to the franchisee. These should be from no more than a year ago.

The franchisor should also give the franchisee the following statement:

“that there has been no change in its financial condition since the period covered by the accounts that would prevent the franchisor from having sufficient funds to meet its current cash needs.”

If the franchisor can’t give such confirmation, the potential franchisee must be given a full explanation as to why.

The People Involved in the Franchisor Business

For each director and senior executive, the following information should be given:

• Name, qualifications (if any)
• Prior related business experience
• Company responsibilities

Confirmation that they’ve never:

• Been declared bankrupt or insolvent
• Had legal action taken against them because of debt (unless they received competent advice to the effect that they had a plausible defence).
• Had a criminal offence conviction (other than a minor traffic violation)
• Been the subject of a ruling barring them from serving as a director or acting in such capacity.

If the franchisee can’t get these details or confirmations, they should be given a full explanation as to why.

The Franchise Offering

The franchise disclosure document should:

• explain how the business works and what goods and services will be provided to the franchisee at the start and in the future.
• include the initial fees (the franchise fee), ongoing licence (royalty) fees, information about how the franchise will be run, and how the parties’ business relationships will be structured.
• include information about the franchise system’s trademarks and how they are protected, which the franchisee should also verify.
• explain how many pilot tests have been done and what the financial results of the test operations were.

The Franchisees

• The number of franchisees they have, who they are, where they conduct business, and when each of them first opened their doors
• The number of franchisees who ended their agreements within the preceding year, and why
• How many franchise agreements the franchisor terminated during that year, and why
• How many current or former franchisees are involved in litigation or arbitration with the franchisor, and why
• The trading history of the proposed territory during the last five years, if the franchisor or any franchisee has previously operated there.

The Financial Projections

• It is important to ensure that franchisees understand that no franchisor can provide an accurate guarantee of future financial performance.
• In terms of gross and net profit estimates, they should be equal to or no better than what the franchisor or, on average, its franchisees have actually accomplished in practice.
• The franchisor must make it clear the option it has selected for the estimate

Each page of the projections should clearly and boldly indicate the following by the franchisor:

“The figures set forth in this illustration represent ACTUAL performance by [either the franchisor or a franchisee.] There is no guarantee that you will achieve these figures and nor is it intended that you should rely on them as a warranty or guarantee”

Claims of Guaranteed Turnover

The BFA believes that a clear disclaimer is needed to protect potential franchisees when turnover or “profits” are guaranteed.

The disclaimer “Guaranteed turnover is not a guarantee of profitability” must appear in all advertisements and publications that present or refer to guaranteed levels of turnover (or earnings, or other similar expressions), in an easily visible style, and reasonably close to the guarantee.

The Franchise Agreement

The franchisor must supply a copy of the franchise agreement to the franchisee. They should, ideally in writing, recommend that they seek legal advice from an independent expert with experience in franchising to make sure that the terms of the contract are clearly explained.

The Franchise Agreement is a legal document that spells out the terms and conditions of the relationship between the franchisee and the franchisor. It should inform both parties what their rights and responsibilities are, how long the agreement will last, dispute resolution and how renewal or termination of the agreement will work.

How Do Prospective Franchisees Get a Copy of an FDD?

Prospective franchisees who want a copy of the Franchise Disclosure Document (FDD) can ask for one directly from the franchisor.

Before signing a franchise agreement, it is essential that aspiring franchisees carefully review this document. Franchisors must send FDDs to them at least 14 calendar days before the signing of the agreement,

Prospective franchisees should hire experienced franchise lawyers to look over the FDD and point out any red flags or concerns.

Getting a copy of the FDD early on in the process is important for making an informed decision and avoiding time wasting.

When do you sign a franchise disclosure document?

It’s important to remember that the FDD is not a contract. Instead, it’s a document that details everything franchisees need to know so they can decide whether or not to invest.

Before signing the FDD, it is important to thoroughly read and consider all of the provided information.

As stated above a prospective franchisee should have received the FDD at least 14 days before signing the franchise agreement.

Conclusion

Disclosure documents are an important part of franchising in the UK because they give potential franchisees all the information they need to make a decision.

Franchisees can get a clear idea of the risks and rewards of the franchise opportunity by carefully reading these documents, and deciding whether or not to invest.

Please note: None of the above constitutes financial and/or legal advice. We advise people to seek their own professional advice suited to their personal circumstances. You can find franchise specialist legal and accounting services in our directory.