What is a disclosure document and why do you need it?

Buying a franchise is an exciting venture, usually the result of much thought and consideration. However, sometimes sifting through the franchise documents can feel a bit like climbing a mountain and any buzz of excitement quickly disappears.

One of the key documents that a potential franchisee will be presented with is a disclosure document.

The disclosure document must be provided to a potential franchisee at least 14 days before the franchisee enters into the franchise agreement.

Properly completed disclosure documents that are compliant with the Franchising Code of Conduct contain much informative, relevant and useful data about the franchisor.

The purpose of the disclosure document is to give potential franchisees information about the franchisor and the franchise opportunity, to enable an informed decision to be made. It will also contain a copy of the Franchising Code of Conduct, the law which regulates franchising in Australia.

Franchisees should read the disclosure document carefully.

Typically, each franchisee should ask the following questions when reading the disclosure document:

• Does the disclosure document follow the format required by the Code?
• Is the disclosure document up to date?

However, franchisees must keep in mind that disclosure documents may not have been completed properly or may provide only the bare minimum of information required under the Code. These documents are usually only updated annually and as a result, some of the data may be outdated. Franchisors often forget or neglect to review their disclosure documents to update obsolete information.

All too often, franchisees review, accept and rely on the information provided in the disclosure document to make a decision about the franchised business without making further enquiries.

If any of the information in the disclosure document later proves to be outdated, untrue, incorrect or missing, franchisees may query whether they would have purchased the business had they been aware of the information or the true position. By this stage, the franchisee may already have incurred losses.

What should you look for in the disclosure document?

Some areas of the disclosure document which prospective franchisees should seek to investigate include:

The people behind the franchisor

Franchisees can ask their professional advisors to undertake searches of the Australian Securities and Investments Commission database to confirm the ownership and officeholders in the franchisor company.

If there are any doubts or concerns, it is possible to conduct additional searches which provide further information in relation to individual directors or shareholders, including their credit history and asset holdings. Bankruptcy searches can also be done.

Items 2 and 3 of the disclosure document provide relevant information regarding the franchisor’s officers and associates and their qualifications and relevant business experience.

Franchisees should review this information carefully and request further details if they consider it necessary.

Litigation

Any information given in Item 4 of the disclosure document relating to proceedings or judgments against the franchisor or its directors or associates should be considered carefully and queries should be asked of the franchisor.

Franchisees should instruct their lawyer to conduct searches of reported and unreported cases to check whether the franchisor has omitted mention of any relevant litigation.

Existing franchises and key events

At item 6.4 of the disclosure document, the franchisor must provide certain information relating to key events in the franchise network in the last three financial years. Key events include franchisee sales, terminations and franchises that have ceased to operate.

To confirm this information and obtain further details, franchisees should talk to as many past and present franchisees of the network as possible. Contact details of current and former franchisees should be contained in the disclosure document.

Franchisees must bear in mind that the opinions of each franchisee interviewed will be subjective and one-sided, but they will also be the best, and only, first-hand account of experiences in dealing with the franchisor and the franchise system.

Intellectual property

Item 8 of the disclosure document should contain details of all trademarks, patents, designs and copyright that is relevant to the franchise system.

Franchisees’ advisors can conduct trademark searches to confirm the status of any trademarks and logos which the franchisor claims to own or use, including registration details and whether any other party has lodged a claim in opposition to the use of any particular trademark. This could ultimately affect the franchisor’s rights to use a trademark or logo and consequently impact on the value of the franchisee’s individual business and the franchisor’s brand as a whole.

Site or territory

Item 9 of the disclosure document contains important details in relation to the extent (or perhaps limitation) of the territory in which the franchisee will be entitled to operate.

Franchisees should ask their advisor to cross-check these details with the corresponding contractual obligations in the franchise agreement to ensure they are consistent and the franchisee is aware of their rights.

Franchisees should also consider the details at Item 13 of the disclosure document, which will reveal the franchisor’s policy for selecting the site or territory and details of any former franchisees which operated in the particular site or territory being granted.

Online sales

Item 12 of the disclosure document requires franchisors to disclose whether the franchisee will be permitted to sell the products of the franchised business or similar products online, and if so, any relevant restrictions.

This Item also sets out details of whether the franchisor or its associates sells online or intends to do so in future, including within the franchisee’s territory. Franchisees should carefully consider this information as it may impact upon the profitability of their business.

Payments and financial data

Franchisors are obliged to provide, at Item 14 of the disclosure document, details of establishment costs and other payments the franchisee can expect to incur in setting up and conducting the franchised business.

Items 20 and 21 of the disclosure document also contain critical financial information, including any projections or earnings information provided by the franchisor, a statement as to the franchisor’s solvency and the franchisor’s financial reports or audit report.

Franchisees should seek accounting advice in relation to all these sections.

End of term arrangements

Item 18 of the disclosure document must contain details as to what will occur when the term of the franchise agreement ends, including specifics of any rights of renewal or extension, the franchisee’s rights to sell the business and details of arrangements that will apply to unsold stock and other items.

Franchisees need this information to assist in making their own plans and arrangements for when the franchise ends.

Legal advice should be sought if a franchisee is unsure of the meaning or effect of any information set out in this section.

General information

A disclosure document that is compliant with the Code and up-to-date should provide prospective franchisees with a considerable amount of relevant information regarding the franchisor and the franchise system. Franchisees and their advisers should thoroughly review and consider the disclosure document and all other documents provided by the franchisor.

However, the information in the disclosure document is only a starting point and should be used as a springboard for prospective franchisees to undertake further research and make additional inquiries.

Using technology, franchisees can instantly access a wealth of information. Internet searches can reveal relevant news articles, industry reports or discussion forums which may provide a different viewpoint.

But remember that not everything that is written can be believed.

It is only with the benefit of complete information that a franchisee can make an informed, well-considered decision about a franchisor, and when a franchisee enters into a franchise with full knowledge and eyes wide open, they will be best prepared for and protected against whatever may come.