A franchise disclosure document contains crucial information to assist prospective franchisees in purchasing a franchise. The information in the disclosure document often includes contact details about the franchisor, statements regarding the operations of the franchise and sets out potential initial and ongoing expenses. The franchisor is also under an ongoing obligation of disclosure and must update the disclosure document on an annual basis.
Disclosure Document and the Code
In franchising, there are a number of legal obligations that fall on both the franchisor (the party granting the franchise) and the franchisee (the party operating the franchised business). A large number of these obligations are set out in the Franchising Code of Conduct (the Code), which is the main law that regulates franchising in Australia.
If you want to become a franchisee, the franchisor is obliged to provide you with a copy of an Information Statement, a copy of the Code, a franchise agreement and a disclosure document. These documents must be provided to the franchisee by the franchisor at least 14 days before you sign the franchise agreement or make a non-refundable payment. The franchise agreement can also not be changed once you have been provided with the copy to review unless the change is for your benefit or to fill in minor details.
What Does a Disclosure Document Contain?
The Franchising Code sets out what must be included in the disclosure document. The disclosure document must contain enough detail and information as to allow the potential franchisee to make an informed decision about becoming a franchisee. The nature of the franchise business will affect the information provided by the franchisor in the disclosure document. For example, a mobile franchise would have different information set out in response to the sections about territory as compared to a franchise that operates from a retail store located in a shopping centre.
Note that although the information contained in the disclosure document is comprehensive, it is unlikely to contain all information about obligations and restrictions for the franchisee.. The franchise agreement is still the main document that governs the relationship between the franchisee and the franchisor.
Below we look at some of the key terms, and things to look out for when reviewing the disclosure document.
The franchisor may, for whatever reason, forget to include some information that is relevant to the franchise in the disclosure document. Over time, there also may be material changes that need to be made to the document. Instead of issuing a brand new disclosure document to all franchisees, The Franchising Code allows the franchisor to distribute extra information under “Other relevant disclosure information”.
Franchisor and Existing Franchisees
The disclosure document must cover terms that provide the following information:
- franchisor details, such as full name, business name, ABN, contact details etc.;
- the relevant business experience of the franchisor and other officers of the franchise network;
- information and contact details of past and existing franchisees;
- how many franchisees renew, transfer or terminate their agreements.
Having a large number of franchisees suggests that the franchise you are entering into is successful. In addition, this section of the disclosure document will also show you whether the franchise has been growing. Notably, a large number of franchisees and an increasing number of franchisees is not a perfect measure as each franchise, even within a single franchise brand, are different.
If you find a trend of franchisees not renewing their franchise agreements, transferring their franchises or terminating the franchise agreement early, this could be a sign that the franchise is facing difficulties. Ask the franchisor to explain why there is this trend, and what they are doing to try and rectify the issues that are resulting in the non-renewals, transfers or terminations.
Franchisors are under an obligation to disclose any past involvement in litigation. Litigation can be unavoidable in some circumstances, so involvement in litigation is not in itself disadvantageous, and the franchisor is required to disclose some context about the litigation. In addition, you can also ask for further information from the franchisor for additional context. Nevertheless, if a franchise appears to have been involved in a significant amount of litigation, this may indicate that there are issues with the franchise, or that they are uncompromising and particularly litigious.
Fees and Expenses
The disclosure document must contain information regarding all fees and expenses that will be incurred by the franchisee if they join the network. Fees and expenses may include:
- initial and ongoing payments, including the start-up fee, royalties, training costs and day-to-day operating expenses; and
- marketing fund contributions and promotional activities.
All fees and expenses must be set out in the disclosure document. Use these amounts to model and forecast the finances for your franchise. Note that subject to limited exceptions, the franchisor cannot require you to pay for any additional expense that has not been disclosed.
The franchisee must also check that the franchisor is financially able to meet their obligations. In the disclosure document you should find:
- a declaration of solvency from the franchisor regarding the business;
- information about the earnings of the franchise, on reasonable grounds; and
- conditions relating to financing, whether offered or required.
Use common sense to judge whether or not you think the franchise network is financially stable, and whether it will continue to be, while you operate as a franchisee.
The most valuable asset of a franchise is its intellectual property. Intellectual property is what distinguishes the franchise from any other business. Intellectual property doesn’t just include the name and the logo, it also includes the image, colour scheme, store layout and the system for delivering the goods or services. The disclosure document should include information about:
- intellectual property (IP), such as business name and logo, owned by the franchise, and what exclusive rights are passed onto the franchisee;
- marketing strategy, which may involve the use and distribution of IP owned by the franchise; and
- confidential information and non-disclosure.
Check to see who actually owns the intellectual property. In some cases, the franchisor does not own the intellectual property and it merely has a licence to use it. The disclosure document will further set out what would happen if the franchisor loses the licence to use the intellectual property. Make sure that this does not affect your franchise and you retain some right to continue to use the intellectual property.
Territory and Online Sales
The disclosure document must cover the:
- territory in which the franchisee may exclusively operate; and
- online sales.
The specified territory is otherwise known as a ‘geographical exclusion’, which prevent franchisees from competing against one another. You should carefully look to see what franchisees already operate around the territory specified for your potential franchise. If they are very close to one another, this may affect the success of your business. Alternately, the specified territory might be extremely far removed from the bulk of the other franchises. It might be worth asking the franchisor what reason their is for this, before jumping into anything.
Almost all businesses now have an online presence and a website from which they offer their goods or services. This can result in the franchisor bypassing your franchise and syphoning sales. The franchisors is required to disclose their online sales channels so that you can take into account whether online sales will affect your business. Alternatively, the franchisor could however be using their online presence for lead generation. In this case, you’ll want to know how online leads are allocated to franchisees and if leads located in your territory are exclusively allocated to you.
The franchisor is under an obligation of ongoing disclosure. This means, subject to limited exceptions, the disclosure document must be updated every year. However updates must also be made to the disclosure document on an ongoing basis in addition to the annual basis where there has been a significant change to the franchise. This includes for example, where an investigation by the regulator has been commenced, or where the franchisor has been sued by a franchisee. You can request to have a copy of the disclosure document provided to you once every 12 months.
The disclosure document is both a legal requirement for franchising, and a crucial element of due diligence prior to entering into a franchise agreement. It should contain all the relevant information about the franchise including names, contact details, operations, expenses, intellectual property and previous litigation. Use the disclosure document to help you understand parts of the franchise agreement and to give you a better idea of how the franchise network operates.