If a company (the “Franchisor”) wishes to offer or sell a franchise located within the U.S., then the Franchisor must either provide a disclosure document or qualify for an exemption (the exemption criteria are listed here).

The FTC Franchise Rule is a specification of exactly what information a Franchisor must disclose to potential franchisees, how that information must be formatted, and what claims cannot be made by a Franchisor.

The Rule requires that the Franchisor disclosure document organize information into 23 sections, each of which has particular requirements for content and formatting. The requirements for each section are summarized below.

1. Basic Details of Franchisor & Franchise Industry

This section must provide the business names, trade names, and principal addresses of the Franchisor and any related companies. It must also provide the info of the registered agent and type of business organization (e.g. general partnership, LLC, corporation, etc) used by the Franchisor.

A “related company” to the Franchisor means a parent company, a subsidiary company, or any other company which is controlled directly or indirectly by the same people or companies as the Franchisor, or any company from which the Franchisor acquired the majority of its assets.

The Franchisor must also disclose in this section whether or not it or any related company operates any businesses of the type being franchised, what other business activities the Franchisor or its related companies are involved in, and details about any other types of franchises sold currently or in the past by the Franchisor or any related companies (including a description of each other line of business, the number of franchises sold in each other line of business, and the length of time each of Franchisor and its related companies has offered franchises in each other line of business).

Regarding the franchise being offered, the Franchisor must describe the business the franchisee will conduct, the general terms of any laws or regulations specific to the industry, a general overview of the market factors (e.g. seasonality, whether goods will be sold to certain groups, whether the market is developed or developing, etc), and a general description of the competition.

2. Business Experience

The Franchisor must disclose the name, current position, and 5 year history of principal job positions (with start and end dates and location) for each “related person” of the Franchisor.

A “related person” of the Franchisor means any person with moderate control in the company or its transactions. It could be a director, trustee, general partner, principal officer, or other individual with relevant management responsibility or authority in that company or related to the franchise being offered.

3. Any Past or Pending Lawsuits

This section must disclose many types of civil and criminal lawsuits that are either pending or were brought (up to 10 years ago) against the Franchisor, any related company of the Franchisor, or any related person of the Franchisor of its related companies. If you have had any legal actions brought against you or any of the companies or people you are connected with in the past 10 years, it’s definitely worthwhile to get the advice of a lawyer on what disclosures you may need to make in this section.

4. Past Bankruptcies

Bankruptcies of the Franchisor or any related companies or related people must be disclosed if they have occurred within the last 10 years. In addition, if any related people of the Franchisor have been principal officers of general partners of other companies that went bankrupt within the past 10 years, those incidents must be disclosed as well.

5. Initial Fees & Refund Terms

Any initial fees (meaning all payments or commitments to pay for services or goods received from the Franchisor or a related company) must be disclosed, along with any conditions under which the initial fees are refundable. If the fees are not uniform, then the formula used to calculate the initial fees must be disclosed.

6. Other Fees

Any other fees must be disclosed with due dates, type of fee, fee amount, and miscellaneous fee details organized into a table formatted according to the rules specified in regulation 16 CFR 436.5(f).

7. Estimated Initial Investment

This section must disclose all estimated initial franchisee expenses such as initial franchise fee, training expenses, real property (whether purchased or leased), equipment, fixtures, fixed assets, initial inventory, security deposits, utility deposits, business licenses, etc. Any specifically required payments must be listed separately by name. All payments and expenses must be accompanied with key details and organized into a table as described in detail in regulation 16 CFR 436.5(g).

8. Restrictions on Sources of Products & Services

This section must provide comprehensive disclosure of the franchisee’s obligations to purchase or lease goods, services, supplies, fixtures, equipment, inventory, computer hardware and software, real estate, or comparable items related to establishing or operating the franchised business either from the Franchisor, its designee, or suppliers approved by the Franchisor, or under the Franchisor’s specifications.

For each such obligation, 11 pieces of information must be provided:

1. The good or service required to be purchased or leased
2. Whether the Franchisor or its related companies are approved suppliers or the only approved suppliers of that good or service
3. Any supplier in which an officer of the Franchisor owns an interest
4. How the Franchisor grants or revokes approval of alternate suppliers
5. Whether the Franchisor issues specifications and standards to franchisees, subfranchisees, or approved suppliers, and if so, a description of how the Franchisor issues and modifies specifications
6. Whether the Franchisor or its related companies will or may derive revenue from required purchases or leases by franchisees, and if so, how exactly the Franchisor receives such benefit
7. The estimated proportion of these required purchases and leases by the franchisee relative to all purchases and leases of goods and services in establishing and operating the franchisee (i.e. what percentage of purchase and lease costs does this obligation represent for the franchisee)
8. If a designated supplier will make payments to the franchisor from franchisee purchases, disclose the basis for the payment (for example, specify a percentage or a flat amount). For purposes of this disclosure, a “payment” includes the sale of similar goods or services to the franchisor at a lower price than to franchisees.
9. The existence of purchasing or distribution cooperatives (i.e. whether the Franchisor and/or franchisee is party to or benefits from a cooperative agreement whereby multiple franchisees and/or other companies aggregate demand to get better bulk pricing)
10. Whether the Franchisor negotiates purchase arrangements with suppliers, including price terms, for the benefit of franchisees
11. Whether the Franchisor provides material benefits (for example, renewal or granting additonal franchises) to a franchisee based on a franchisee’s purchase of particular products or services or use of particular suppliers

9. Franchisee’s Obligations

This section must provide a table describing all of the franchisee’s principal obligations, including any obligations related to each of the following items:

• Site selection and acquisition / lease
• Pre-opening purchase / leases
• Site development and other pre-opening requirements
• Initial and ongoing training
• Opening
• Fees
• Compliance with standards and policies / operating manual
• Trademarks and proprietary information
• Restrictions on products / services offered
• Warranty and customer service requirements
• Territorial development and sales quotas
• Ongoing product / service purchases
• Maintenance, appearance, and remodeling requirements
• Insurance
• Advertising
• Indemnification
• Owner’s participation / management / staffing
• Records and reports
• Inspections and audits
• Transfer
• Renewal
• Post-termination obligations
• Non-competition covenants
• Dispute resolution
• Other (describe)

10. Financing Arrangements

This section must disclose the terms of each financing arrangement, including leases and installment contracts, that the Franchisor or its related companies or related people or its agents offer, directly or indirectly, to the franchisee. All the financing arrangements should be organized into a table that provides the following information for each arrangement:

• What the financing covers (e.g. the initial franchise fee, site acquisition, opening inventory, ongoing inventory, etc)
• The identity of each lender providing financing and their relationship to the Franchisor
• The amount of financing offered or, if the amount depends on an actual cost that may vary, the percentage of the cost that will be financed
• The interest rate, plus finance charges, expressed on an annual basis
• The number of payments or the period of repayment
• The nature of any security interest required by the lender
• Whether a person other than the franchisee must personally guarantee the debt
• Whether the debt can be prepaid and if so, the nature of any prepayment penalty
• The franchisee’s potential liabilities upon default
• any other material financing terms

In addition, this section must disclose whether any loan agreement requires franchisees to waive defenses or other legal rights or bars franchisees from asserting a defense against the lender, the lender’s assignee or the franchisor.

The Franchisor must also disclose whether it is its intent or standard practice to sell, assign, or discount to a third party all or part of the financing arrangement as well as whether the Franchisor or any related company receives consideration for placing financing with the lender.

11. Franchisor’s Assistance, Advertising & Systems

This section must disclose the Franchisor’s main assistance and related obligations of both the Franchisor and franchisee. The following particular issues must be covered:

1. Disclose the Franchisor’s pre-opening obligations to the franchisee, including any assistance in locating a site, negotiating the purchase or lease of a site, conforming the premises to local ordinances and building codes, obtaining any required permits, constructing or remodeling or decorating the premises, hiring and training employees, and providing any necessary equipment, signs, fixtures, opening inventory, and supplies.
2. Disclose the typical length of time between the earlier of the franchise agreement signing or first franchise payment and the opening of the franchisee’s business.
3. Disclose the Franchisor’s obligations to the franchisee during the operation of the franchise, including any assistance in developing products or services, hiring and training employees, improving and developing the franchised business, establishing prices, establishing and using administrative and bookkeeping procedures, or resolving operating problems encountered by the franchisee.
4. Disclose the advertising program for the franchise system, including any Franchisor obligation to conduct advertising, the circumstances when the Franchisor will permit franchisees to use their own advertising material, whether there is an advertising council composed of franchisees that advises the Franchisor on advertising policies, whether the franchisee must participate in a local or regional advertising cooperative, whether the franchisee must participate in any other advertising fund, how unused advertising funds are used and accounted for at the end of a year, and the percentage of advertising funds, if any, that the Franchisor uses to solicit new franchise sales.
5. Disclose whether the Franchisor requires the franchisee to buy or use electronic cash registers or computer systems.
6. Disclose the table of contents of the Franchisor’s operating manual provided to franchisees as part of the Franchisor’s last fiscal year-end or a more recent date.
7. Disclose the Franchisor’s training program.

The requirements for this section are actually much more in depth both in required content and content formatting. The complete set of requirements is described in regulation 16 CFR 436.5(k).

12. Territory

The Franchisor must disclose each of the following:

1. Whether the franchise is for a specific location or a location to be approved by the Franchisor
2. Any minimum territory granted to the franchisee (for example, a specific radius, a radius sufficient to encompass a specified population, or another specific designation)
3. The conditions under which the Franchisor will approve the relocation of the franchised business or the franchisee’s establishment of additional franchised outlets
4. Franchisee options, rights of first refusal, or similar rights to acquire additional franchises
5. Whether the Franchisor grants an exclusive territory
6. For all territories (exclusive and non-exclusive), any restrictions on the Franchisor from soliciting or accepting orders from consumers inside the franchisee’s territory, any restrictions on the franchisee from soliciting or accepting orders from consumers outside his or her territory, and details of any situation if the Franchisor or a related company operates, franchises, or plans to operate or franchise a business under a different trademark that sells or will sell similar goods or services to those of the franchisee

There are more details for each item that must be included in this section (as described in regulation 16 CFR 436.5(l)).

13. Trademarks

This section must include the following disclosures:

1. Disclose each principal trademark to be licensed to the franchisee. (Principal trademark means the primary trademarks, service marks, names, logos, and commercial symbols the franchisee will use to identify the franchised business, but it may not include every trademark the Franchisor owns).
2. Disclose whether each principal trademark is registered with the United States Patent and Trademark Office (USPTO).
3. If any principal trademark is not registered with the USPTO, then disclose whether the Franchisor has filed any trademark application.
4. If a trademark is not registered on the Principal Register of the USPTO, state: “We do not have a federal registration for our principal trademark. Therefore, our trademark does not have many legal benefits and rights as a federally registered trademark. If our right to use the trademark is challenged, you may have to change to an alternative trademark, which may increase your expenses.”
5. Disclose any currently effective material determinations of the United States Patent and Trademark Office, the Trademark Trial and Appeal Board, or any state trademark administrator or court; and any pending infringement, opposition, or cancellation proceeding. Include infringement, opposition, or cancellation proceedings in which the Franchisor unsuccessfully sought to prevent registration of a trademark in order to protect a trademark licensed by the Franchisor. Describe how the determination affects the ownership, use, or licensing of the trademark.
6. Disclose any pending material federal or state court litigation regarding the Franchisor’s use or ownership rights in a trademark.
7. Disclose any currently effective agreements that significantly limit the Franchisor’s rights to use or license the use of trademarks listed in this section.
8. Disclose any obligations of Franchisor or franchisee to notify and/or indemnify the other of trademark infringement claims.
9. Disclose whether the Franchisor knows of either superior prior rights or infringing uses that could materially affect the franchisee’s use of the principal trademarks in the state where the franchised business will be located.

14. Patents, Copyrights and Proprietary Information

1. Disclose whether the Franchisor owns rights in, or licenses to, patents or copyrights that are material to the franchise. Also, disclose whether the Franchisor has any pending patent applications that are material to the franchise.
2. Describe any current material determination of the United States Patent and Trademark Office, the United States Copyright Office, or a court regarding the patent or copyright. Describe how the determination affects the franchised business.
3. State the forum, case number, claims asserted, issues involved, and effective determinations for any material proceeding pending in the United States Patent and Trademark Office or any court.
4. If an agreement limits the use of the patent, patent application, or copyright, state the parties to and duration of the agreement, the extent to which the agreement may affect the franchisee, and other material terms of the agreement.
5. Disclose the Franchisor’s obligation to protect the patent, patent application, or copyright; and to defend the franchisee against claims arising from the franchisee’s use of patented or copyrighted items.
6. If the Franchisor knows of any patent or copyright infringement that could materially affect the franchisee, disclose the nature and details of such infringement.
7. If the Franchisor claims proprietary rights in other confidential information or trade secrets, describe in general terms the proprietary information communicated to the franchisee and the terms for use by the franchisee. The Franchisor need only describe the general nature of the proprietary information, such as whether a formula or recipe is considered to be a trade secret.

15. Participation in Franchisee Operations

1. Disclose the franchisee’s obligation to participate personally in the direct operation of the franchisee’s business and whether the Franchisor recommends participation.
2. If personal “on-premises” supervision is not required, disclose any Franchisor recommendations, limitations, training requirements, and equity interest requirements for on-premises supervisors.
3. Disclose any restrictions that the franchisee must place on its manager.

16. Restrictions on what the Franchisee May Sell

Disclose any franchisor-imposed restrictions or conditions on the goods or services that the franchisee may sell or that limit access to customers, including:

1. Any obligation on the franchisee to sell only goods or services approved by the Franchisor
2. Any obligation on the franchisee to sell all goods or services authorized by the Franchisor
3. Whether the Franchisor has the right to change the types of authorized goods or services and whether there are limits on the Franchisor’s right to make changes

17. Renewal, Termination, Transfer, Disputes

Disclose, in the particular tabular form specified in regulation 16 CFR 436.5(q), a table that cross-references each enumerated franchise relationship item with the applicable provision in the franchise or related agreement. Each of the following items must be included in the table (but can be marked “not applicable” if such is the case):

• Length of the franchise term
• Renewal or extension of the term
• Requirements for franchisee to renew or extend
• Termination by franchisee
• Termination by Franchisor without cause
• Termination by Franchisor with cause
• “Cause” defined – curable defaults
• “Cause” defined – non-curable defaults
• Franchisee’s obligations on termination/non-renewal
• Assignment of contract by Franchisor
• “Transfer” by franchisee – defined
• Franchisor approval of transfer by franchisee
• Conditions for Franchisor approval of transfer
• Franchisor’s right of first refusal to acquire franchisee’s business
• Franchisor’s option to purchase franchisee’s business
• Death or disability of franchisee
• Non-competition covenants during the term of the franchise
• Non-competition covenants after the franchise is terminated or expires
• Modification of the agreement
• Integration/merger clause
• Dispute resolution by arbitration or mediation
• Choice of forum
• Choice of law

18. Public Figures Involved in Franchise

Disclose:

• Any compensation or other benefit given or promised to a public figure arising from either the use of the public figure in the name or symbol, or the public figure’s endorsement or recommendation of the franchise to prospective franchisees.
• The extent to which the public figure is involved in the management or control of the Franchisor. Describe the public figure’s position and duties in the Franchisor’s business structure.
• The public figure’s total investment in the franchisor, including the amount the public figure contributed in services performed or to be performed. State the type of investment (for example, common stock, promissory note).

For purposes of this section, a public figure means a person whose name or physical appearance is generally known to the public in the geographic area where the franchise will be located.

19. Financial Performance Representations

There are certain boilerplate statements that must be made in this section. The exact statements are provided in regulation 16 CFR 436.5(s).

If the Franchisor makes any financial performance representation to prospective franchisees, the Franchisor must have a reasonable basis and written substantiation for the representation at the time the representation is made and must state the representation in this section 19 disclosure. The Franchisor must also:

• Disclose whether the representation is an historic financial performance representation about the franchise system’s existing outlets, or a subset of those outlets, or is a forecast of the prospective franchisee’s future financial performance.
• If related to past performance of the franchise system’s existing outlets, disclose the material bases for the representation must be included. See the regulation linked above for the details of what is considered material.
• If the representation is a forecast of future financial performance, disclose the material bases and assumptions on which the project is based must be disclosed.
• Provide a clear and conspicuous admonition that a new franchisee’s individual financial results may differ from the result stated in the financial performance representation.
• Provide a statement that written substantiation for the financial performance representation will be made available to the prospective franchisee upon reasonable request.

If a Franchisor wishes to disclose only the actual operating results for a specific outlet being offered for sale, it need not comply with this section, provided the information is given only to potential purchasers of that outlet.

If a Franchisor furnishes financial performance information according to this section, the Franchisor may deliver to the prospective franchisee a supplemental financial performance representation about a particular location or variation, apart from the disclosure document, provided certain criteria laid out in the regulation linked above are complied with.

20. Outlets and Franchisee Information

Include the following disclosures:

• The total number of franchised and company-owned outlets for each of the Franchisor’s last three fiscal years, organized into the tabular form shown in regulation 16 CFR 436.5(t)
• The number of franchised and company-owned outlets and changes in the number and ownership of outlets located in each state during each of the last three fiscal years. Organize the info into the forms of the second, third, and fourth tables in the regulation linked above
• The projected new franchised and company-owned outlets, organized into the form of table 5 from the regulation linked above
• The names of all current franchisees and the addresses and telephone numbers of each of their outlets
• The contact info of every franchisee who had an outlet terminated, canceled, not renewed, or otherwise voluntarily or involuntarily ceased to do business under the franchise agreement during the most recently completed fiscal year or who has not communicated with the Franchisor within 10 weeks of the disclosure document issuance date
• If a Franchisor is selling a previously-owned franchised outlet now under its control, disclose the following additional information for that outlet for the last five fiscal years
• Whether franchisees signed confidentiality clauses during the last three years
• To the extent known, the contact info of each trademark-specific franchisee organization associated with the franchise system being offered

21. Financial Statements

The following financial statements must be provided in accordance with GAAP or SEC rules, and with a franchise startup exception discussed precisely in regulation 16 CFR 436.5(u), these statements must be audited by a CPA using GAAP standards.

• The Franchisor’s balance sheet for the previous two fiscal year-ends before the disclosure document issuance date
• Statements of operations, stockholders equity, and cash flows for each of the Franchisor’s previous three fiscal years

Financial statements should include separate information for any subsidiaries and subfranchisors.

22. Contracts

You must attach a copy of all proposed agreements regarding the franchise offering, including the franchise agreement and any lease, options, and purchase agreements.

23. Receipts

Certain boilerplate attachments must be included in the disclosure document. The details are provided in regulation 16 CFR 436.5(w).