As part of a proper due diligence process, prospective franchisees should be collecting pertinent information on franchising and franchise systems. They should also be evaluating it against their goals, attributes, capabilities, and assets. During due diligence, some of this information (financial capacity, skills, passions) will come from the franchisee, while other details will come from the franchise system. An important piece of this investigation puzzle is the franchise disclosure document. Here’s how you can put these valuable resources to best use and glean as much information as possible.
What is a franchise disclosure document?
A franchise disclosure document is a written resource designed to provide franchisees with vital information that they need in order to make an informed decision about investing in a franchise opportunity.
A typical franchise disclosure document may include information such as:
- Background on the franchisor and its key figures, such as its directors and officers
- Any history of litigation, civil actions, convictions, bankruptcies, etc. of the franchisor and/or its directors and officers
- A summary of any trademarks and other intellectual property
- A summary of the costs and fees required to start and run the franchise business
- An outline of the training and ongoing assistance provided by the franchisor
- A list of current and former franchisees and their contact details
- Financial statements and other fiscal information
The disclosure document must meet the requirements set out in any provincial franchise legislation. Currently, British Columbia, Alberta, Manitoba, Ontario, New Brunswick, and Prince Edward Island have specific legislation on franchising.
Prospective franchisees are given a minimum of 14 days to review the document prior to signing on with the franchise.
Will a disclosure document specify how much money a franchisee can make?
Franchisors can, but aren’t required to, provide information on projected earnings. As a variety of factors can play into the success of a franchise location, it can sometimes be difficult—and risky—for franchisors to provide earnings claims that apply widely.
The financial information that franchisors will include in the disclosure documents is likely to include the franchisor’s overall fiscal performance during the most recent year (which will show the assets, liabilities, and earnings of the franchisor itself) and/or historical actual gross sales of anonymous individual locations. Franchisees are advised to review all financial statements with an accountant, who can explain the numbers and use them to extrapolate the financial viability of the franchise system and to help put together a solid business plan for the prospective franchisee.
No matter how the financial information is presented, though, the franchisor must be able to substantiate and justify the information.
Another way to find out more about earnings potential is to speak with existing franchisees.
When will a prospective franchisee receive a franchise disclosure document?
The timing for the provision of a disclosure document to a prospective franchisee can vary from system to system.
Just as a prospective franchisee will be evaluating the franchise opportunity, the franchisor will also be assessing whether the applicant would be a good fit for the system. Once the prospective franchisee is considered a serious candidate, that’s usually the point where the franchise disclosure document comes into play.
What should a prospective franchisee do with a franchise disclosure document?
When a disclosure document is provided, a prospective franchisee has a minimum of two weeks in which to review the materials. The franchisee should not sign any contracts or agreements until this period has passed. Don’t delay in reviewing—there’s a lot to be done and two weeks can go by quickly.
The first step is to gain a full understanding of the information it contains, with help from an experienced franchise lawyer.
A franchise lawyer will be able to “translate” all the essential rights, responsibilities, and obligations that the documents outline pertaining to both sides of the franchise relationship.
The lawyer will also point out anything different or unusual about the information or what the franchisor requires and can often identify items that may be negotiated with the franchisor (and lead these negotiations when the time comes).
In addition to speaking with a franchise lawyer, there are others a prospective franchisee should consult during this time, such as an accountant and banker, who may also want to review the disclosure document.
Remember the list of franchisees provided with the disclosure document? Put it to good use by contacting current and former franchisees for their first-hand knowledge.
Franchise disclosure documents play an important role in a franchisee’s due diligence. By consulting with franchise professionals, a disclosure document can help prospective franchisees make their investment decision with a better understanding of the franchise opportunity, as well as the rights, responsibilities, and obligations they’ll be undertaking as a franchisee.