Is this the most important document in franchising?
The Franchising Code of Conduct requires franchisors to provide each prospective franchisee with a disclosure document.
This is undoubtedly the most important document that a franchisee receives when entering into a franchise relationship. It contains considerable information about the franchisor and franchise brand and is designed to give a franchisee all of the information they need to make a reasonably informed decision.
Franchisors are required by the Code to give a prospective franchisee a copy of their disclosure document at the beginning of the mandatory 14 day disclosure period. This is to afford a franchisee the time to review the agreement and disclosure document and receive independent advice, without being pressured into hastily signing the agreement.
Franchisors are also required to update their disclosure document within four months of the end of each financial year to ensure that it is up to date for any prospective franchisees and that it is compliant with their disclosure obligations in the Code.
What type of information is required for disclosure?
The Code prescribes the list of all questions that a franchisor must answer in their disclosure document. This includes the relevant history and experience of the franchisor and its directors or officers. This is important as it can provide comfort to a franchisee that the people operating the franchisor have extensive experience and expertise in operating similar successful businesses or a long history in overseeing the franchise network.
A disclosure document should be read in conjunction with the franchise agreement as it will give a franchisee a complete list of all costs and fees that they will be liable for. This includes all costs that are applicable at the start of a franchise agreement as well as the recurring costs during the operation of the business including anticipated costs to third parties through the term.
Franchisees should utilise this information to understand the financial implications of owning and operating the franchise business. Franchisees should always seek independent financial advice so that they make an informed decision regarding their financial liabilities when entering into a franchise agreement.
A franchisor must disclose the status of all their franchisees and the circumstances in which any franchise has ceased to operate during the previous three years. While the opinions of these franchisees may be one-sided, contacting current and past franchisees can be a valuable way to learn what it is like to be part of the franchise network.
Franchisors must also disclose any current litigation or recent judgements against the franchisor or its directors and associates which can provide further useful information. If any legal proceedings or judgements are disclosed this should be further investigated by a franchisee and their lawyer prior to entering into the franchise agreement.
Choosing the right site for a franchise business can greatly affect the success of a franchise. Item 9 and item 13 of a disclosure document give the franchisee information regarding the territory which may be provided and whether any other party may have the right to offer similar services in the territory.
These details should be checked to ensure they match the contractual clauses of the franchise agreement.
An important area of a disclosure document is the end of term arrangements. This part of a disclosure document discloses whether the franchisee has any rights of renewal or extension or a right to sell the business. As a franchise agreement is only for a specific term, a franchisee should be mindful of these rights and take them into account when signing the agreement.
Financial and auditing requirements
A franchisor is also required to provide copies of audits or financial statements regarding the franchisor entity. This provides the franchisee with the information to gauge the health of the franchisor and assures the franchisee that the franchisor is operating a viable business model that can provide support to its franchisees.
Franchisor’s also have disclosure obligations regarding their marketing funds and must disclose meaningful information to prospective franchisees about how the fund has been applied in the previous year and what kinds of expenses the fund may be used for.
Under the Code a marketing fund may only be used for the items disclosed to prospective franchisees in its disclosure document. It is also a requirement that a marketing fund be independently audited each financial year and this audit must be shared with all franchisees.
In general, an up-to-date and compliant disclosure document should provide prospective franchisees with much of the relevant information that they require regarding a franchisor and its franchise system.
A disclosure document is an important tool to allow a potential franchisee to conduct its due diligence on the franchisor and the franchise network.