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Franchise disclosure documents and financial components

Franchising can be a good option for those looking to become successful small business owners. This type of business can relieve one from the many uncertainties that accompany a startup, but it is important to understand the financial components within the disclosure document. Before making any commitments, the U.S. Small Business Administration recommends researching the company thoroughly to ensure that the franchise is a good fit. By interviewing other franchise owners and reviewing all disclosed documentation carefully, a potential franchisee can avoid any unnecessary issues or surprises down the road.

The Federal Trade Commission Bureau of Consumer requires franchisors to disclose information about the costs related to becoming a franchisee in a franchise disclosure document. In this document, the company must include the fees and expenses the potential franchisee will be required to pay, including the following:

 

  • Franchise fee

  • Initial inventory costs

  • Ongoing costs such as royalties

  • Required equipment

  • Training and advertising expenses

 

The disclosure document often provides financial information regarding the success of other franchisees, and even what a potential franchisee may expect to earn. The disclosure document may include financial performance representations to demonstrate potential earnings. These potential income or sales numbers do not have to be provided, but when they are included, franchisors are legally bound to provide a reasonable basis for the claims.

A potential franchisee should keep in mind that even when earnings information is provided, it could be factual while still misrepresenting the truth. For example, the income average may be skewed by a minority of successful franchisees who inflate the numbers. The franchisor may also provide gross sales, but these create an incomplete picture because they only show revenues. Even when sales are high, expenses such as rent or high overhead may still cause a loss rather than a profit.

The FTC’s Amended Franchise Rule is intended to protect franchisees from fraud through disclosure of company information. Careful evaluation of this document allows individuals to more fully recognize all the risks and benefits before signing a contract.

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