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WHAT SHOULD A DISCLOSURE DOCUMENT CONTAIN?

by Simon Lord,
last updated 11/11/2009

A good disclosure document is a great help when buying a franchise. What should it tell you?

When buying a franchise, the best systems provide the prospective purchaser with a document that sets out all the salient facts about the company and what it is selling. This is called the Disclosure Document, and its aim is to ensure that prospective franchisees understand the nature of the franchisor/franchisee relationship prior to purchasing, and that they have all the necessary information on which to base an informed decision.

The following provides a guide to what a disclosure document should contain. There is no legal requirement for such a document in New Zealand but good systems will still provide adequate disclosure. The Franchise Association of New Zealand does outline a minimum standard in its Franchising Code of Practice although most franchises operating in New Zealand are not members of the Association.

In many cases, owing to the nature of the information provided, prospective franchisees will be required to sign a confidentiality agreement before receiving the disclosure document. This is perfectly normal.

Disclosure

Franchisors should provide a disclosure document to all prospective franchisees at least 14 days prior to signing a franchise agreement. This disclosure document should be updated at least annually and contain at least the following:

1. A company profile with details of the company and its officers. The purpose of this is to enable the potential franchisee to do their own checking of the particulars of the people involved in the franchisor company.

2. An outline of the franchise, including:

  • History of the system
  • Trade mark particulars
  • Details of all payments to be made by the franchisee to the franchisor
  • Details of any amount refundable if the agreement is terminated after a deposit is paid
  • A summary of terms and conditions for purchase of goods
  • A summary of terms and conditions relating to termination, renewal, goodwill and assignment of the franchise
  • Summary of the main obligations of the franchisor

The aim of this section can be summed up as ‘No nasty surprises'. By setting out clearly the terms and conditions upon which the franchise is to be sold and operated well in advance of signing an agreement, the franchisor is ensuring the clearest possible understanding of the nature of the deal for the potential franchisee.

 

Commissions

The document should disclose details of any payment or commission made by the franchisor to any advisor, broker or consultant in connection with the sale. A potential franchisee has the right to know if the broker who recommends the franchise to him or her will benefit financially by doing so.

Financial

There should be a list of components making up the franchise purchase - for example, the franchise fee, stock, fixtures and fittings, working capital and so on, along with costs. It should also include details of any financial requirements by the franchisor (eg. required equity levels) and a certificate of solvency signed by the directors of the franchisor company.

References

The document should contain a list of existing franchisees and company outlets, along with details of any franchises terminated or not renewed in the past year and information on any outstanding litigation. Prospective purchasers are always well-advised to talk to existing franchisees about any system which interests them; this makes the process easier, and also encourages them to check other details.

Projections

Where figures are included, they must be clearly qualified as to whether they are examples of actual performance achieved, or if they are projections. If the latter, the basis of any assumptions made must be included. There must also be a clear statement of what is and is not included (for example, wages or the cost of servicing loans) and confirmation that the figures do not represent a guarantee of performance.

Purchasers can reasonably expect an outline of what the business they are buying might achieve, but this is an area fraught with danger as, in business, nothing is certain. The purpose here is to qualify the figures by explaining exactly how they are arrived at and why they are relevant to the purchaser's specific business.

Other

The disclosure document may also contain details of any deposits required, whether they are refundable or non-refundable, and whether there is any ‘cooling off' period during which a franchisee may change their mind after signing a franchise agreement.

Summary

By offering an accurate, up-to-date and detailed disclosure document, a franchisor ensures that prospective franchisees have a clear understanding of the franchise, its obligations and financial requirements. This achieves two important objectives. First, it protects the franchisor against misunderstandings or later allegations of misrepresentation. Secondly, it enables prospective franchisees to carry out proper ‘due diligence' on the franchise in question.

The moral is: if you're buying a franchise, ask for the disclosure document, check what it contains and show it to your advisors before you make your decision.

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