There are various documents needed to start a franchise, which are prescribed by the Federal Trade Commission in its Amended Franchise Rule (the “FTC Rule”) found at 16 CFR 436. The FTC Rule requires franchises to be sold through a very specific process. The first step in that process is the franchisor providing a prospective franchisee with a franchise disclosure document. In the franchising world, the franchise disclosure document is universally referred to as an “FDD.” The FDD is an offering prospectus similar to certain documents that must be prepared for securities offerings.
The FDD will be approximately 100 to 300 pages for most franchisors. For large franchise systems such as McDonald’s, the FDD can be several hundred pages long due to extensive exhibits and long lists of franchisees. The FTC Rule dictates the minimum requirements for documents that must be in the FDD.
Within the FDD, the first section is comprised of disclosures under twenty-three “Items.” Each “Item” must disclose specific information about the franchise offering. There is flexibility in the exhibits that come after the disclosure Items. However, one of the exhibits must include the franchise agreement. The franchise agreement is the actual binding contract between the franchisor and the franchisee. The disclosure Items are not binding as they are just required for informing the prospective franchisee of the terms of the franchise agreement. The franchise agreement may include its own exhibits as well. Exhibits to the franchise agreement may include a credit card authorization form, statement of ownership of the franchisee if this party is an entity, personal guaranty, territory specifics, lease rider, and certain documents the franchisee must utilize in the operation of its franchise among other things.
Another document found in many FDDs is a multi-unit agreement. Some franchise systems call this a “Multi-Unit Development Agreement” while others call it an “Area Development Agreement.” Ultimately, this is a much simpler contract than the franchise agreement that grants a franchisee or a “developer” the right to create and operate multiple units of that particular franchise. This is in contrast to an area representative agreement, which grants an area representative the right to sell franchises within a specific territory.
Some other documents involved in forming a franchise include letters of intent, trademark license agreements, and operations manuals. Letters of intent can be useful between owners of a new franchise system or between the franchisor and its first couple of franchisees. Trademark license agreements are necessary if the franchisor entity does not own the trademarks associated with the franchise system. The owner of the trademarks will have to license them to the franchisor along with granting the franchisor the right to sublicense the trademarks to franchisees.
Operations manuals are key for new franchisors. The FTC Rule requires that the table of contents to the operations manual be included in the exhibits to the FDD. It is important for a franchisor to have a robust operations manual so that their franchisees have instructions for running the franchised business. On one hand, a solid operations manual keeps franchisees from bugging the franchisor frequently about common things that could be communicated through the manual. On the other hand, a franchisor is more likely to be sued for failing to provide support to its franchisees if the operations manual does not adequately provide guidance to the franchisees.