One of the many things that I advise my clients who are prospective franchisees to do, is to make sure that they are familiar with Items 5, 6 & 7 of the FDD they were provided. I believe that our most important function as franchise lawyers advising prospective franchisees is to educate our clients on the obligations they are undertaking and the expectations they should have of the franchisor. Item 5 details the up front fees that will be paid to the franchisor. Item 6 details the on-going fees paid to the franchisor and its affiliates. Item 7 details the costs and expenses that a franchisee would expect to have to pay in the first few months of operating the business. I will describe each Item in more depth below.
Item 5 is called the “Initial Fee Paid to the Franchisor”. This is called the “Initial Fee”, but encompasses more than just the franchise fee. This Item should disclose all fees that are paid to the franchisor prior to the franchisee opening for business. This Item could include the cost of any goods or services paid to the franchisor prior to the business opening, training charges, and any other fees paid to the franchisor in this initial state of the franchise relationship.
Item 6 is called “Other Fees”. This Item is a chart that details the other fees paid to the franchisor and its affiliates. Examples of the fees included in Item 6 would be royalties, advertising (national, regional and local) fees if paid to the franchisor or an affiliate, service fees, training charges, lease payments if made to the franchisor or an affiliate, transfer and assignment charges, late fees, finance charges, payments for bookkeeping services paid to the franchisor or an affiliate, payments for goods and services paid to the franchisor or an affiliate, payments made to the franchisor or an affiliate for assistance with the build-out or furniture, etc.
Item 7 is called the “Estimated Initial Investment”. This Item is shown as a chart which details the likely charges (stated in a range of fees) for various expenditures that a franchisee may incur in the first few months of operating the business. Typical expenses listed include, rent, leasehold improvements, franchise fee, utility charges and deposits, furniture, fixtures and equipment, vehicles (if required), computers, software, insurance, signs, office supplies and equipment, licenses and permits, legal and accounting fees, working capital, etc. A prospective franchisee should take note that the cost of the franchise is really a great deal more than just the up-front franchise fee.
As a franchise attorney, I know that the footnotes to each Item in the FDD are the most important details presented for each Item. Clients typically just want to know the bottom line, but unfortunately no one can tell them that. It is critical to learn as much as you can about the franchise, the franchisor, the business itself, and everything that is disclosed in the FDD. Every prospective franchisee should read through the entire 23 Items of the FDD and understand them. These Items are supposed to be written in “plain English” for that purpose. Reading through the FDD is just one important piece of the due diligence I strongly recommend to all prospective franchisees. For further due diligence suggestions, please see my other blogs on this topic.