FLN FranchiseLAW
By Michael H. Seid and Michael E. Sheehan
Improving the Franchise Buying Process
W
e’re going to say something
here that at first blush may
seem to be complete heresy to advocates of business format franchising:
the process of selecting a franchise
often can fail. It’s not the franchise itself that may flunk. It’s the regulatory
components of the buying process that
may miss the mark.
The regulatory process
The regulatory framework for franchising in the United States is somewhat
out of date as it is structured around a
formula-driven disclosure document,
the FDD. The current FDD format
and content goes back to the 1960s,
before personal computers were common, before the Internet, and before
franchising matured. Over time there
have been relatively minor changes to
the format of the FDD. The most recent
changes took place in 2007 and many
people believe that those changes actually weakened disclosure. The current
FDD falls short of meeting the needs
of first-time franchisees and franchisors
in general, and its weakness is a root
cause of much of the proposed regulatory fixes we have seen lately.
Franchisors are required to follow a fairly precise, uniform set of
rules on how to inform prospective
franchisees about their opportunity.
In some states, for better or worse,
franchisors must first present their
documents for review and approval
to regulators. The regulatory process
can be very positive, but it also has
serious limitations as franchisors often
have to limit disclosure to meet the
uncertainty and lack of uniformity of
the state regulatory review process.
For example, it’s unlawful to “fail to
include the information and follow the
instructions for preparing” FDDs, and
we are limited by the bulk-up provisions limiting information that might
yield the best available disclosure.
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Limitations of the FDD process
Let’s take a few examples that illustrate
how the FDD regime can fall short on
its implicit promise of full disclosure.
Foremost among the instances of the
FDD’s information gaps is the muddle
that constitutes the fees and estimated
initial investment disclosures of Items
5 through 7. While you will learn a lot
about the cost of investing in a franchise
through these disclosures, you will
certainly not learn what may be most
significant to a prospective franchisee:
the total investment. That’s because
Item 7 gives you only a partial picture
of your start-up costs.
The information probably most important to prospective franchisees—historical or projected earnings data—also
may be lacking, as Item 19 is a voluntary disclosure. Subject to very limited
exceptions, franchisors are prohibited
from disclosing any earnings information to prospective franchisees if they
opt out of Item 19, and there may be
solid reasons not to provide such disclosures. In an information world with
data of every sort (accurate and inaccurate) available 24/7, did the regulators somehow believe that prospective
franchisees would not marry up unit
cost data with unit sales data from the
Internet and reach potentially inaccurate or misleading conclusions?
The shortcomings of FDD disclosure
reside primarily in its one-size-fits-all
framework. Most reasonable people probably would agree that a freshly launched
franchise presents different challenges
than those faced by a seasoned brand.
Also, information needed by a singleunit franchisee making an investment
decision is substantially different than
that required by a sophisticated multiunit developer.
What may make more sense is blending some elements of a tiered disclosure
in which franchisors might include a
“principles-based approach” that permits some amount of discretion with
respect to disclosure (in addition to
the 22 specified areas). Rather than
adhering mechanically to an inflexible
set of rules, franchisors could instead
rely on a road map for added disclosure
composed of key disclosure objectives,
guidance explaining the objectives, and
some common examples that illustrate
that guidance.
Under a blended approach that includes a principles-based disclosure
component, franchisors and their counsel
likely will have a greater challenge in
crafting good disclosure, but the process
will evolve over time. But many franchisors (and franchise attorneys) currently
view the task of drafting disclosure as
following a cookbook. Enhancing disclosure would enable franchisors, and
not simply regulators, to decide what
additional information is important and
how best to present that information for
the benefit of prospective franchisees.
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