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 themselves, while other details will come from the franchise system. An important piece of this investigation puzzle is the franchise disclosure document. Here, FranchiseCanada goes to legal experts to get the facts on 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.
“The information contained in the disclosure document is all directed at providing the basic information that any party looking to invest in a business would be requiring before they invest,” explains Peter Snell, a franchise lawyer and partner at Gowling WLG’s Vancouver office.
“Before spending a lot of their time and money on a franchise business, franchisees need to be making an informed decision and a disclosure document is required to give a franchisee the material info they need to know,” says Chad Finkelstein, a franchise lawyer and partner with Toronto-based Dale & Lessmann LLP.
A typical franchise disclosure document may include information such as:
- Background on the franchisor – history of the company, what it offers and how it is operated, how long it has been in operation, how many units/franchises it has, other brands it operates
- Background on the key players within the system, such as its directors and officers, and those one would deal with as a franchisee
- Any history of litigation, civil actions, convictions, bankruptcies, etc. of the franchisor and/or its directors and officers
- A summary of the trademarks and other intellectual property that are licensed under the franchise agreement
- 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 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?
“The first question many franchisees ask is, ‘How much can I really make at this?’” Snell says. “The answer is, ‘It depends.’”
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 possibly 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.
“Ideally, prospective franchisees should bring it to their accountant, someone who reads these types of statements every day and can identify what looks normal or, possibly, not-so-normal,” Finkelstein says.
No matter how the financial information is presented, though, as Snell points out, “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. “Sometimes they will give you the hard data, but often it’s more anecdotal,” says Snell. “If they’re unhappy they’ll want to tell you about it, and if they are happy they’ll be sure to tell you how great it is and how much they love it.”
When will a prospective franchisee receive a franchise disclosure document?
The timing of providing a disclosure document to a prospective franchisee can vary from system to system.
“Some will give a disclosure document upfront – they may bring them to franchise tradeshows, for instance,” says Finkelstein. “In general, franchisors aren’t likely to give a disclosure document to a prospective franchisee until they’ve been vetted a bit. This might mean that they’ve filled out an application form and provided some background information on themselves, such as experience, work history, and net worth.”
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 they consider the prospective franchisee a serious candidate, that may be the point where the franchise disclosure document comes into play.
“Giving the disclosure document can be a bit of a risky proposition for franchisors simply because it contains so much important information on the company and not every province permits a franchisor to get a non-disclosure agreement from a franchisee,” Finkelstein says. “Generally, they want to make sure that they have a very viable candidate before it’s provided.”
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. The two weeks should go by quickly though, as there is much to be done.
“It’s important that a franchisee uses this time wisely to make an informed decision based on the content of the disclosure document,” says Finkelstein.
The first step is a full understanding of the information it contains. An experienced franchise lawyer can assist with this.
“Disclosure documents and agreements are a unique type of license and require a level of background and expertise that is developed over time by practitioners who specialize in this area,” Snell says. “In reviewing the documents, a franchise lawyer will be able to see anything which is unique, different, or in some way stands out from what is typical in a franchise arrangement.”
A franchise lawyer will also be able to “translate” to the prospective franchisee all the essential rights, responsibilities, and obligations that the documents outline pertaining to both sides of the franchise relationship. Snell stresses how important it is for franchisees to enter into franchising with “his or her eyes wide open.”
“Often, franchisees are very excited about investing in a brand. That’s a fantastic start,” says Snell. “The challenge is to focus that excitement and focus in on the details. For someone who is not trained in reviewing complex legal documents, it can be easy to not recognize the elements that need to be reviewed carefully and this is part of the value of a franchise lawyer.”
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).
Finkelstein says that in addition to speaking with a franchise lawyer, there are others a prospective franchisee should consult during this time.
“Franchisees should definitely be speaking with an accountant and with their banker, and talking it over with their friends and family,” he says. In many cases, these professionals will also want to review the disclosure document or parts thereof to get a realistic view of what investing in the system would mean financially.
Franchisees will also want to put that list of franchisees the disclosure document provides to good use. “They should definitely be contacting franchisees, both current ones to find out what life is like currently in the system and former ones to find out why that franchisee is no longer a part of the system,” Finkelstein explains.
Using the two-week period to gather inside and specialized information is critical, he says, adding that franchisors should also be encouraging their prospects to go out and obtain as much advice and knowledge as possible.
“Because there is a lot of information in the disclosure document and lots of things to do and consider, it generally does take the full two weeks to look at everything in its entirety,” says Snell.
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.