Need for pre-franchise sale disclosures

Thursday May 9 2019

Wambugu Wa Gichohi

Wambugu Wa Gichohi 

The Franchise Disclosure Document (FDD) is a document that franchisors should prepare and present to prospective franchisees in the pre-franchise sale disclosure process.

It aims to protect franchisors from allegations of misleading claims and potential franchisees from franchisor misrepresentations.

It is therefore deceitful and an outright con for potential franchisors to rely only on a Franchise Agreement (the formal sales contract they quickly get from lawyers) to engage potential franchisees.

The FDD underlies the Franchise Agreement. Avoiding to prepare it is informed by utter ignorance of international best practices of franchise documentation requirements, not being bound by a Code of Ethics and Business Practices franchisors would otherwise sign upon joining a world-recognized franchise association, inexistence of laws requiring preparation and sharing, outright crookedness of aspiring franchisors or a combination of these.

The World Franchise Council (WFC)-the world apex body of franchise associations and the world-recognized body for self-regulation of the franchise sector-advocates minimum legislation to govern franchising.

In fact, WFC has a model franchise law to be used by countries wishing to regulate franchising. My advice to potential franchisees normally is; before engaging a franchisor ask if they are members of any franchise association recognized by the WFC-particularly franchisors coming into Africa where franchise-specific laws are altogether inexistent, only a few countries mention franchising in their other laws and where only a handful of (largely inactive) franchise associations exist.

The FDD originated in the United States (USA) where early business format franchising was shaped.

The International Franchise Association (IFA) of the USA is the world’s oldest franchise association and played a pivotal role in creating the WFC.

Prior to the 1978 Federal Trade Commission (FTC) Rule in the USA, franchisors could easily take advantage of gullible franchisees.

The would conceal critical information for the latter to collect franchisees’ joining fees, only for franchisees to later learn that some of these franchises were untenable.

Given the seriousness attached to pre-franchise sales disclosures in the USA under the 1978 FTC Rule, a franchisor who doesn’t disclose material facts is sued by the government (Federal or State) rather than giving private rights to franchisees to sue.

The FDD easily equates to The Prospectus prepared by a company prior to listing at a stock or securities exchange.

The two are similar in that they disclose the current and past performance of the business to enable prospective investors to make informed decisions.

They are different, however, in that in franchising, more than when listing at a stock exchange, non-disclosure is more harmful to investors-hence more critical details in the FDD. Unlike investors buying shares and other securities during an IPO who would normally invest “excess income” in a business run by managers guided by a board of directors, potential franchisees invest their “active incomes” and time to own and run franchises of another business.

Even where they borrow to acquire a franchise, it is normally a requirement that at least half the investment is in cash from own sources.

Misrepresentation can be very expensive for potential franchisees. Franchisees run franchised outlets as own businesses unlike in listed companies where shareholders wait for financial year ends to know their dividend earning status.

Franchisees pay the franchisor a joining fee plus monthly royalties and marketing fees. If material facts were concealed initially, sooner than later this will be exposed and ugly scenes will ensue.

Even with no franchise-specific or consumer protection laws and with weak franchise associations, it is important that aspiring franchisors follow international best practices on pre-franchise sale disclosure.

The writer is the Lead Franchise Consultant at Africa Franchising Accelerator Project. We work with country apex private sector bodies to increase the uptake of franchising by helping indigenous African brands to franchise.

We turn around struggling indigenous franchise brands to franchise cross-border. We settle international franchise brands into Africa to build a well-balanced franchise sector.

We create a franchise-friendly business environment with African governments for quicker African integration.,