Becoming a franchisor opens the door to grow your business with a strong, expanding network, but it also brings a new set of legal responsibilities — especially when it comes to ongoing franchise compliance. For early-stage franchisors, the rules can feel overwhelming, but they’re essential to avoid costly mistakes down the road. These are some of the common components of a compliance process that we assist our clients in establishing:
Managing Disclosure
Completing your first franchise disclosure document is a massive undertaking – once complete, you will likely be eager to get it into the hands of your prospects. Upon launching your franchise sales process, you will need to manage proper disclosure, tracking, and applicable state regulations.
Proper disclosure rules require specific waiting periods that your prospects must have both the completed FDD in their hands, as well as their specific franchise agreements, prior to signing on the dotted line. The most basic of these rules is that a franchisor must give a prospect the FDD at least 14 days prior to signing of a binding agreement or payment of money in connection with the proposed franchise sale. Franchisees must also have their franchise agreements, with all material terms filled in, at least 7 days prior to signing or paying money to you.
Tip: The 7 and 14 day waiting periods requires FULL days – so you should start your count on the next full day after they receive the FDD or Franchise Agreements from you.
Not all states treat franchising equally. Some states allow you to sell freely as long as you are federally compliant, and some have their own rules – including registration of your FDD. Some states will require a state-specific Franchise Disclosure Document with terms required by that jurisdiction. All of this means that you will need to track where you are engaging in sales activity, ensure you are utilizing an FDD registered in that state, and include any applicable disclosures and documents specific to that state.
Tip: Know where you are engaging with your leads. Even if you’re based in a non-registration state, activity in a registration state triggers those rules.
Tip: Your FDD must be provided in a single, continuous document, in the specific order in which it was put together. No extraneous materials or tools to navigate the document (link hyperlinks) may be included.
update requirements
We like to remind our clients that there are ongoing update requirements when certain events occur. One of these requirements is predictable – all franchisors are required to make an annual update between 90-120 days after the end of their fiscal year (depending on the applicable state regulations). For most entities with a December 31 fiscal year end, March or April are the target update months.
Best Practice: We work with our clients to strategically target an issuance date based on their existing sales activity and applicable deadlines.
Tip: One of the most time-consuming parts of the annual update process is finishing your annual financial statement audit. We recommend kicking that process off 3 months prior to your target issuance date.
A lesser known update requirement is triggered in the event of a ‘material change.’ The definition of a material change can vary by state – but generally includes events that might affect a franchisee’s decision to purchase. This can be related to executive team turnover, effects on financial performance, material litigation or fee changes.
Best Practice: We provide our clients with a list of potential events that constitute a material change, in order to trigger a thought to contact us upon certain occurrences.
sales compliance
What franchisors ‘can and can’t’ say in the franchise sales process is a key component to a new franchisor’s successful growth. Creating disclosure issues in the sales process can have material repercussions later on. Rules prohibit a franchisor from any representation or promise that is contrary to the FDD. Even offhand comments from team members can lead to disclosure issues. Common triggers are any guarantees of results, promises of success, promises of future operational support, and unit-level performance that is contrary to your FDD. Refer to our subsection on the sales process for more detail on this hot topic!
Best Practice: We provide ongoing training of your sales team (even if it is just you) – which we view as essential to ongoing compliance.
advertising fund compliance
Many franchisors choose to implement a system-wide marketing fund – whereby they collect a percentage of sales from their franchisees on a monthly basis that are deposited into a fund created for the benefit of the system. Maintaining this fund comes with some important ongoing compliance requirements. First, clear processes on how you track and manage the fund are important – you would be surprised at how many franchisors have trouble accounting for actual amounts that were collected or spent from the fund. Second, franchisors must disclose how the funds were spent on an annual basis. Make sure you distinguish what constitutes an advertising fund expenditure, and keep clear records to back it up.
establishing system pricing
While franchisors can set system standards and require franchisees to use certain products or vendors, they generally cannot dictate what prices franchisees charge their end customers. This is because franchisees are considered independent business owners, and price fixing between independent entities can violate federal antitrust laws. Franchisors must work within the applicable restrictions to come up with best practices surrounding their pricing strategy.
Tip: Many franchisors establish maximum and minimum price standards, pricing tiers, and pricing promotional campaigns, to establish some control around pricing considerations.
These key points are just a sample of ongoing compliance issues that we work with our clients to ensure that they are covered on an ongoing basis. When in doubt, give us a call so we can provide recommendations on best practices.
