One popular way for entrepreneurs to start a new small business is to buy a franchise. But, to be successful, you need to do some research and work before you decide to buy a franchise. On a personal level, you need to consider numerous things, such as how much you can afford to invest, whether you can get financing and if you have the experience necessary to run and operate a business.
Of course, one of the first things you need to consider is, out of the thousands of franchise opportunities out there, which one is right for you. It's a difficult decision, considering that your initial investment in any franchise will typically be between $10,000 to $50,000, and maybe more. But, there are federal and state franchise registration and disclosure rules and regulations that can help you make the right decision.
Federal Rules and Regulations
The Federal Trade Commission (FTC), which is the nation's consumer protection agency, regulates how a "franchisor" (the owner of the goods or system) can sell you (the "franchisee"), a franchise, which essentially is the right to sell the franchisor's goods or services under the franchisor's name.
Under the FTC's franchise disclosure rule, which became effective July 1, 2008, franchisors are required to disclose specific information about their franchise to prospective franchisees. This document is called a "franchise disclosure document (FDD)."
The FDD requires the franchisor to disclose over 20 kinds of financial and business information as well as a copy of the franchise agreement that you'll have to sign when you buy the franchise. The information that the franchisor must disclose includes things like:
- The franchisor's background, which tells you how long the franchisor has been in business, the franchisor's likely competition, and any special laws that might apply to the franchised business, such as special license or permit requirements
- Current and recent litigation by and against the franchisor, including whether the franchisor or any of its executive officers have been convicted of crimes involving fraud or violations of franchise law, and whether the franchisor has sued a franchisee during the last year
- Bankruptcy filings of the franchisor or its officers
- The costs involved in starting and operating a franchise, including deposits or franchise fees that may be non-refundable, and costs for things like initial inventory, signs, and equipment.
- Restrictions on things like from who you have to buy supplies, what goods you can sell, and where you can sell (your "territory")
- Trademarks the franchisor will allow you to use, such as a trade name, like the name of a restaurant, and any other protected property, like recipes
- Financial statements that should indicate the franchisor's current financial condition
There are other costs associated with a franchise which the franchisor might (but doesn't have to) disclose, so you might want to ask about costs like ongoing royalty fees, supply costs, and insurance
Potential earnings are probably very important to you. Franchisors are not required to disclose information about potential income or sales. But if they do, the franchisor must have a reasonable basis for what it claims and must be able to substantiate or "prove" its claims.
The FTC has no registration requirement, that is, franchisors don't have to file their FDDs with any federal agency.
Finally, you have to be given the FDD at least 14 days before you are asked to sign any contract or pay any money to the franchisor.
State Rules and Regulations
Only 15 states have pre-sale disclosure laws for franchise sales that franchisors must follow. Generally, the state laws mirror the FTC's disclosure requirements, and the disclosures are called "offering circulars" or "disclosure statements." However, several of these states also require franchisors to file their statements with a state agency.
The 15 states with disclosure requirements are California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Oregon, Rhode Island, South Dakota, Virginia, Washington, and Wisconsin. Of these states, only Michigan and Oregon do not require registration.
In the states that have them, the registration requirements vary, but generally, the franchisors have to file:
- An application and a registration fee
- Copies of the offering circular that contains all things required by the state's law
- Copies of the franchise agreement and financial statements of the franchisor
- Copies of any advertising to be used in connection with the offer or sale of the franchise
If your state does not have franchise disclosure laws, franchisors are required to follow the FTC's disclosure rules.
If a franchisor does not follow the FTC's rule, the FTC can file a lawsuit in which it could get a court order telling the franchisor to stop its non-compliance, an order that the franchisor refund any fees paid by a franchisee, or assess fines against the franchisor of up to $11,000 per violation.
State law remedies vary, but generally, a franchisee can file a lawsuit to have the franchise terminated and to recover money damages.
Questions for Your Attorney
- Can I e-mail an FDD or offering circular to a potential franchisee, or do I have to mail or deliver a paper copy? Can I just post it on my Web site?
- Do I have to give an FDD to anyone who asks, or can I wait until I know that the potential franchisee is serious about buying?
- I didn't get an FDD from a franchisor. Should I call the FTC?
- Will the FTC look at an FDD and tell me if my potential franchisor has complied with the FTC's disclosure requirements?