You've finally decided on the right franchise for you, secured the loan to purchase it, and now you're ready to sit down to sign all the paperwork. The franchise agreement is something we've discussed before. That's one of the biggest things you must pay attention to, but the franchise rule is something else to be aware of. The franchise rule is actually in place for your protection. It is set forth by the Federal Trade Commission to help franchisees make informed decisions and to help prevent deception in the sale of franchises by requiring franchisors to provide prospective franchisees with important information prior to the sale of the franchise. While this does sound good for the potential franchisee, it's important to understand what exactly is covered under this rule.
What Is the Franchise Rule?
The Franchise Rule requires franchisors to make material disclosures in five categories:
- The nature of the franchisor and the franchise system.
- The franchisor's financial viability.
- The costs involved in purchasing and operating a franchised outlet.
- The terms and conditions that govern the franchise relationship.
- The names and addresses of current franchisees who can share their experiences within the franchise system, helping the prospective franchisee to verify independently the franchisor's claims.
As mentioned above, the franchise rule gives potential purchasers of a franchise the information they need to examine and compare the risks and benefits of making such a life-changing investment, with the end result being that the potential buyer is making an informed buying decision. The rule requires franchisors to provide all potential franchisees with a disclosure document that includes 23 specific items of information (in five categories) about the offered franchise, its officers, and other franchisees. Keep in mind, it doesn't regulate the substance of the terms that control the relationship between franchisors and franchisees. Full details of what needs to be included regarding each of the 23 items can be found in the Federal Trade Commission document entitle "
Franchise Rule Compliance Guide," which can be acquired by visiting the Federal Trade Commission website. It is quite detailed and strongly recommended reading if you are going to buy a franchise.
Some of the items that you'll find here include:
- Initial Fees.
- Additional Fees.
- Restriction on Sources of Products and Services.
- Franchisee's Obligations.
- Financing.
- Contracts.
As you can see from the list above, there will be a lot to go over when you purchase a franchise. At the time of the purchase, you sit down to sign the papers and much of this information can be found in the franchise agreement that you sign. The franchisor is required to go over all of this with you line by line, but many new buyers, excited by the reality of becoming a business owner, simply sign without paying much attention to any of this material. That's why it's always a good idea to step back and let your lawyer go over the contracts and all of the information the franchise gives you. While you might think it's okay to sign an agreement without reading just because you are signing an agreement with a well-known brand, it isn't ever a good idea to sign without knowing everything you can about the company you are going to tie your future, and your money to.
While the 23 items addressed specifically in the franchise rule appear to cover everything, under each of those items there is a list of specifics that have inclusions, exclusions, and additional information that can vary from state to state. Depending upon the state you are in, there are guidelines for franchisors that must be met specifically to that state's regulations. Again, this is why investing in a lawyer before you read and sign is advisable, especially if you aren't at all familiar with the language of business and the finer points of contracts. For instance, the FTC franchise rule does not require franchisors to disclose the unit performance statistics of the franchised system to new buyers of franchises under the financial section of the franchise rule, which could be misleading if you aren't aware of the "whys" behind it.
This may sound like a lot to take in, but much of it is covered as a matter of course as you go through the process of purchasing a franchise. When you are considering buying a franchise and during the entire process, ask all the questions you can think of. Having a lawyer is helpful here too because your lawyer will know what to ask. Buying a franchise is a huge financial investment for your future. It's an investment in time as well. You want to be sure before you enter into an agreement that you are making the right choice and that you can meet all of the expectations on your part of the agreement. Knowing all you can about the franchise up front helps you make an informed decision before you sign the dotted line.
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