Breaking Down the FDD

SPECIAL SECTION: PART 2

Breaking Down the FDD

Item 8: Restrictions on Sources of Products and Services

By Nicole Micklich

Part of buying into a franchise system is accepting the notion that if you play by the rules, you get the benefits of brand awareness and franchisor support. Item 8 of the FDD discusses suppliers and lays out sourcing restrictions for products and materials, which is especially important in food-based concepts.

Item 8 can be very revealing, so it’s important to understand. The franchisor may negotiate arrangements with approved vendors, and these arrangements may result in some franchisees paying more for certain items than if they bought the same items elsewhere. For example, a franchisor may designate only one approved supplier for cleaning products. The franchisor’s arrangement with the supplier results in advertising contributions to the franchisor, which the franchisor can allocate to any market. This arrangement obviously works well for the franchisor—but it may have seemingly little benefit for a franchisee.

A franchisee, in a market that does not receive those advertising dollars, might prefer a brand of cleanser that costs half the price of the approved brand. But using a different product can put the franchisee out of compliance. And, as a franchisee, you stand to benefit from the brand awareness developed by the franchisor.

ITEM 16: RESTRICTIONS ON WHAT THE FRANCHISEE MAY SELL This item should disclose any restrictions or conditions relating to what a franchisee sells. It may say, “We require you to offer and sell only those goods and services that we have approved. You must offer all goods and services we designate as required for all franchisees.” This means every franchisee must offer all the required products or services. On the other hand, Item 16 may reveal that franchisees in certain regions may offer different products, because regional preferences may vary.

Sometimes a system has additional goods or services that are optional for qualified franchisees. Item 16 might inform that optional services can be offered by franchisees in compliance with certain obligations. For example, an auto service concept might allow qualified franchisees to offer rustproofing services to customers. Only franchisees who are in compliance and have undergone specific training required by the franchisor may be permitted to offer rustproofing services. If these kinds of optional services can lead to increased profitability, they’re worth knowing about.

Item 16 should also explain whether the franchisor has the right to change the types of good or services the franchisee can sell, and if there are any restrictions on that right. FDDs often indicate that there are no limits on the franchisor’s right to add, modify, or delete products and services that franchisees are required to offer. The FDD may say, “We reserve the right to add additional required goods and services in the future and to withdraw goods and services we previously authorized.” And would add, “There are no limits on our right to do so.” However, sometimes there is a restriction or possible exceptions, and in that instance, the FDD could say, “There are no limits on our right to do so, except that the investment required of a franchisee for equipment, supplies, and initial inventory will not exceed $15,000 per year.” Or, “There are no limits on our right to do so, but we may make limited exceptions based on special circumstances, although we are not required to do so.” When franchisors change the types of goods or services the franchisees can sell, it can be costly for franchisees. It’s important for prospective franchisees to understand the franchisor’s rights and limitations. For instance, a franchisor might disclose: “We have the right to designate additional required goods and services and to withdraw any previous approvals. There are no limitations on our right to do so.” Or, a franchisor might state: “We have the right to add additional required services. There are no limits on our right to do so, except that the investment required of a franchisee for equipment, supplies, and initial inventory will not exceed $15,000 per year.” Prospective franchisees should consider whether the franchisor can change requirements during the term of the franchise agreement.

Nicole Micklich is a franchise attorney with Garcia & Milas. Contact her at 203-773-3824 or nmicklich@garciamilas.com