What is the FTC Franchise Rule?
The Federal Trade Commission (“FTC”) governs the rules imposed upon franchises. The current Franchise Rule requires the Franchisor to provide extensive disclosure to the prospective Franchisee regarding the business before the Franchise Agreement is signed. This mandatory document is called the “Franchise Disclosure Document” and covers 23 items. The latest amendments to the Franchise Rule have been approved in 2007. The FTC Franchise Rule full Compliance Guide can be found on the Federal Trade Commission’s website.
What is a Franchise Disclosure Document (FDD)?
The Federal law (FTC Rule on Franchising) requires preparation of a Franchise Disclosure Document (FDD) when a new franchise is formed. The FDD must be given to the potential Franchisee 14 days before the Franchisee is able to sign the Franchise Agreement. The purpose of such disclosure to a potential Franchisee has historically been to allow the Franchisee to make an informed decision. An FDD typically includes a fees chart, the franchise’s legal and financial history, along with other terms and conditions of the operation of the franchise.
What type of Franchise Fees are There?
Franchise fees are typically determined by the Franchisor but can also often be negotiated with the Franchisee at the time of the drafting of the Franchise Agreement. Upon the signing of the Franchise Agreement, the Franchisee pays the Initial Franchise Fee. This is a one-time payment made to the Franchisor. Apart from that, the Franchisee is typically responsible for the payment of ongoing fees such as:
- Royalty fees. These fees are usually calculated as a percentage of the Franchisee’s gross revenue. The Franchisors establish royalty fees in the Franchise Agreement. These fees could also include continuing training of administration and staff, equipment rental, etc.
- Advertising fees. These fees can be set as a fixed amount or as a percentage based on the Franchisee’s sales revenue and are meant to contribute to the promotion of the entire franchise.
It is worth noting that fees established in an already-signed Franchise Agreement are typically difficult to change without affecting the Franchisor/Franchisee relationship. It is usually much easier for a Franchisor to change his fees in future Franchise Agreements with future Franchisees.
When Should you Update your FDD?
An FDD is typically required to be updated at least once a year. Another instance when an FDD has to be updated is the occurrence of a “material event” in the Franchisor Company. An event is “material” if it is likely to affect consumers’ conduct in regard to a purchase. For example, a change in fees (Royalty, Service or the Initial Franchise) is considered to be a “material event”. Typically, the FDD needs to be updated 30 to 45 days after the occurrence of a material event.