Item 8 describes the limitations that a franchisor places on its franchisees with regard to the furniture, fixtures, equipment, supplies, inventory, computer systems, and other goods and services that the franchisee will need to lease or purchase to open and operate the franchised business. If you require the franchisee to lease or purchase items that meet particular specifications, or if you require the franchisee to lease or purchase items from only certain suppliers, this information must be disclosed in Item 8. In Item 8, you will need to disclose:
- Any item where the franchisee must abide by standard specifications that the franchisor requires. Many franchisors require their franchisees lease or purchase items that meet certain specifications. Common examples are computer hardware and software and the types and coverage minimums of insurance policies.
- Any item where the franchisee must use a designated supplier. For example, Joe’s Place may require franchisees purchase their French fries from a particular potato supplier. This restricts the franchisee from shopping around to maybe get a better price elsewhere. Importantly, you must disclose whether the franchisor itself or one of its affiliates is a designated supplier, or the only approved supplier, of any required good or service. You must also disclose whether any of your officers owns an interest in any designated supplier.
- Any situation where there may be a financial gain for the franchisor from purchases made by the franchisee. If the franchisor, or one of its affiliates, receives any revenues from leases or purchases by franchisees, it must be listed in Item 8. If the franchisor or one of its affiliates is the only approved supplier for a certain good or service, then the total amount of annual revenue received will be included here. If any supplier will make payments, or provide other material benefits, to the franchisor based on franchisees’ purchases, that needs to be explained here, too. For example, if a supplier will pay a rebate to the franchisor, we need to state how that rebate is calculated (whether it is a flat amount, such as $1/case of syrup, or a percentage, such as 2% of franchisee’s invoice price). Also, if a supplier gives the franchisor a break on the costs of certain items for corporate-owned outlets, that also needs to be disclosed. So, if a designated supplier charges your franchisees $5/case of product but only charges you $3/case of product, you need to disclose this.
You also need to disclose in Item 8 the percentage of overall required purchases that are restricted by your specifications or required suppliers. This information lets prospects know their freedom to shop around for better prices or for items of their own personal preference.
We encourage you to stay away from product markups as it is an irritant to franchisees. For example, rather than charging an extra $2 a case for an item the franchisee can get at a local supplier, go to that supplier and suggest that rather than pay you $2 a case, where you estimate you’re going to sell 10,000 cases to your franchisees next year, have the supplier give you a $20,000 sponsorship to support your annual meeting. It’s the same dollars, but now it’s viewed as a loyal supplier supporting the education and betterment of the franchisees instead of a kickback.
Be greedy long-term. You’re in this business, not for $2 for a case, but to sell the system for $20 to $30 million. And you get there by having happy franchisees that feel you are on their side. Your franchisees need to make money. It might sound obvious and straightforward. However, it is the single most crucial factor in your long-term success. If all you’re doing is milking your franchisees, you’re not going to build long-term sustainable value.
Sample Item 8
ITEM 8: RESTRICTIONS ON SOURCES OF PRODUCTS AND SERVICES
You must purchase your pipe bending machine, hoist, cutting torch, mufflers, exhaust pipe, and other supplies under specifications in the operations manual. These specifications include standards for delivery, performance, design, and appearance. Our specifications are formulated by our engineering department and may be modified periodically, in consultation with the Belmont Franchisee Advisory Council.
Required and approved suppliers
You must purchase required equipment from Belmont or an approved supplier. Belmont’s affiliate, Belmont Muffler Manufacturers, Inc., is an approved supplier of mufflers. Our President, Jane Doe, owns an interest in Belmont Muffler Manufacturers, Inc. We have also approved three other suppliers of mufflers and exhaust pipe, as listed in our operations manual.
Approval of alternative suppliers
Belmont may approve other suppliers of mufflers and exhaust pipe who meet the specifications set forth in the operations manual. If you would like to purchase these items from another supplier, you must request our “Supplier Approval Criteria and Request Form.” Based on the information and samples you supply to us and your payment of a $500 fee, we will test the items supplied and review the proposed supplier’s financial records, business reputation, delivery performance, credit rating, and other information. Our review typically is completed in 30 days. Approval of alternative suppliers may be revoked if our engineering department determines that their mufflers and exhaust pipe fail to satisfy the specifications set forth in the operations manual, as it may periodically be updated.
Revenue from franchisee purchases
In the year ending December 31, 2007, Belmont’s revenues from the sale of equipment to franchisees was $500,000, or 5% of Belmont’s total revenues of $10,000,000. The cost of equipment and supplies purchased in accordance with our specifications will represent 50-60% of your total purchases in establishing the business and 20-30% of your total purchases during operation of the business.
In the year ending December 31, 2007, Belmont Muffler Manufacturer’s Inc.’s revenues from the sale of mufflers to franchisees was $2,000,000. The purchase of mufflers from Belmont Muffler Manufacturers will represent 10 to 15% of your overall purchases in establishing and operating the business. Belmont Muffler Manufacturers, Inc., pays us a .05% rebate on all mufflers purchased from franchisees.
One of the three approved suppliers of mufflers and exhaust pipe pays Belmont a rebate of 1% of all franchisee purchases.
We do not have any purchasing or distribution cooperatives.
We negotiate purchase arrangements with Belmont Muffler Manufacturers, Inc., including the price terms.
We do not provide any material benefits to you if you buy from sources we approve.
This is a sample section from a fictional FDD for Belmont Muffler Shops that was prepared by the Federal Trade Commission as a compliance guide for franchisors preparing their FDD. These are used to provide an idea of what these items may look like in an FDD, but keep in mind, your FDD will most likely vary significantly from these examples.