Definition: A regulatory document describing a franchise opportunity that
prospective franchisees have to receive before they pay any money,
sign any papers or, in some cases, even meet with the franchisor
If you're interested in purchasing a franchise, you'll want to
be sure to get a copy of their Uniform Franchise Offering Circular
(UFOC) and review it from cover to cover. It's after you've
contacted a franchisor and filled out their questionnaires to
determine whether you fit the profile of "their kind" of franchisee
that you'll receive two documents in the mail. One will be the
UFOC, which contains 23 items of information about the franchise,
and the other will be the franchise agreement. State and federal
laws require that the franchisor give you these documents at least
10 days before taking your deposit and signing you on as a
franchisee. If you don't receive them, you should be sure to ask
about them.
Carefully examine the information in these documents before
consulting with your CPA and attorney. Just because these documents
appear to comply with the FTC rules and/or various state filing
requirements doesn't mean they do or that the terms are in your
favor. Most of those regulations only require the franchisor to
make complete and full disclosure of various categories of
information the law requires in the document. So long as the
disclosure is made in the proper manner, the franchisor can draft
the terms and conditions of its franchise and its obligations to
you as a franchisee in almost any manner it wishes.
The first section in the UFOC is a brief history of the
franchise. The history should document who founded the company,
when it began doing business, incorporation dates if any, and when
it first started franchising. This data lets you know what kind of
expertise and experience the franchisor has to offer. A franchisor
who has only been in business for a few years and began franchising
a year after start-up doesn't have a lot of experience in the
business.
The next section discusses franchise fees and royalties. The
front-end franchise fee and royalties are fully disclosed. The
continual royalty (usually monthly) may run up to 15 percent, and
an additional advertising royalty may be 5 percent or more. The
front-end franchise fee may be $1,000 to $300,000 or more. It
usually does not include the costs involved in actually starting
the business, such as inventory, equipment, facility, and leases.
Make sure to include these fees in your financial projections, so
you can accurately gauge the business' ability to generate profits
in the future.
Next is a section that contains a brief summary of the officers,
directors, and other executives. Read carefully to determine their
level of experience and expertise. See if any have ties with
suppliers or vendors from whom you'll purchase supplies or
inventory and whether such ties present conflicts of interest.
The UFOC will also include a brief description of any major
civil, criminal or bankruptcy actions that the officers and
executives have been involved in or that the franchise company is a
party to. Lawsuits are common today, and the fact that someone has
been sued or has filed suit does not necessarily indicate problems.
However, if the lawsuits involve problems with franchisees or
vendors, or if they are numerous, investigate further to determine
the stability and integrity of the franchisor.
The terms of the franchise agreement are one of the most crucial
parts of the UFOC and one that you need to review carefully. Many
franchisors offer initial terms of five to ten years with options
to renew for additional periods. However, it is not uncommon to
encounter agreements for five-to-ten year terms with no option for
renewal. This means that when the initial term expires, the
franchisor may terminate the franchise and open his own company
store, or charge the franchisee a large fee to continue. If the
franchise agreement does not give you an option to renew, you have
no protection and could lose all the goodwill you built up during
the period you operated the business.
Franchisors are required to list an approximation of the initial
costs of starting the franchise in addition to the franchise fees.
Those costs usually include equipment, inventory, operating
capital, and insurance. Keep in mind that these costs are estimates
and are not inclusive. In fact, many franchise litigation
specialists point out that franchisors show zero working capital or
an unrealistically low figure. If there is a working capital figure
located in Item Seven of the UFOC, ask if it includes operating
expenses for the business until it is fully self-supporting,
including an owner's salary. When interviewing other franchisees,
ask them what they consider sufficient working capital for the
first year of operation. Most important, have your CPA help you put
together your own estimates.
Although some franchisors will supply you with projections of
the sales and expenses of a new franchise location, most won't.
This area is heavily regulated by the FTC to prevent franchisors
from making unfounded claims. Now, however, more franchisors are
beginning to provide projections. This shift in philosophy is due
to regulatory changes in the late 1980s, which provided guidelines
for franchisors on how to present earnings information.
A large section of the UFOC lists the many reasons a franchisor
may terminate before the contract expires. They include poor
condition of the location, failure on the part of the franchisee to
pay royalties in a timely manner, failure to supply an account, and
excessive customer complaints.
If you're deemed a "good," i.e. "profitable," franchisee, the
franchisor will not use these clauses to end its relationship with
you. However, if the franchisor thinks it can operate the location
better than you can, or has a more desirable applicant for the
location, it may use one of those reasons to attempt to terminate
you. Therefore, if you sign on, you must be careful to comply with
all conditions that, if not met, permit termination.
Regardless of the UFOC provisions permitting termination, some
states have strong laws that can make it difficult for the
franchisor to terminate a franchise early. Much of the litigation
between franchisors and franchisees involves attempts on the part
of franchisors to terminate franchisees' licenses prematurely.
Never assume that purchasing a franchise will give you an
exclusive, protected territory. Many UFOCs state that you do not
receive an exclusive territory but that it is the "policy of the
franchisor" not to locate another franchise within three miles.
However, "policies" can and do change. The UFOC may also say that
if the franchisor decides to open another location in your area,
you have the right of first refusal to purchase the new location.
Another common provision allows you exclusivity in an area only if
your sales are maintained at a certain predetermined level.
Read carefully the sections outlining the franchisor's
responsibilities to you. Usually those obligations include
providing you with a training manual, picking a suitable location,
training you and/or an employee, helping plan or attending the
grand opening, and offering some sort of continuing assistance with
advertising and managing the store. In addition, you usually have
the right to use certain trademarked symbols and names for the term
of the franchise.
The UFOC usually includes only a general description of the
duties the franchisor has to the franchisee. Therefore, before
signing on, ask to see the manual, learn more about the training,
and meet the franchisor's personnel who are going to assist you.
And, if you're still interested, make sure to get your lawyer's and
CPA's blessings before you sign on the dotted line.