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Why is the Franchise Disclosure Document Hard to Understand?

When franchising and franchised businesses started to take off in the 1960s and 1970s, the typical franchisee was an individual who, after working for others for decades, decided that he or she wanted to start his or her own business. Knowing that new businesses had as much chance to fail as to succeed, the budding entrepreneur would try to increase his or her odds of success by investing money in a franchised business. Of course, many of these people fell victim to the claims and promises of unscrupulous people who promised all sorts of things, but had no trademark, no training, no experience, no marketing plan and no support.

To protect the prospective franchisee, many states--and finally the federal government--required that those offering franchised business opportunities would have to provide a prospectus to a prospective franchisee before the person could sign a franchise agreement or invest in the franchised business. The prospectus would have to include all of the material information--and only the material information--which the prospective franchisee would need in order to make an informated decision. The identity of a typical franchisee has changed dramatically; there are now many large companies and sophisticated investors who are franchisees. However, the prospectus--formerly called the Uniform Franchise Offering Circular, and now called the Franchise Disclosure Document ("FDD")--is still required today.

The FDD is supposed to be written in a style to minimize confusion and obfuscation. However, as pointed out by author Russ Garland in a recent (April 30, 2018) Wall Street Journal article, at least one study produced a finding that a person needs at least 20 years of education in order to understand the FDD. Why?

Some people believe that the franchisor tries to hide unfavorable information by making its FDD disclosures hard to understand. I disagree: The regulations of what can appear in an FDD, and the increasing move toward graphs and tables, make it difficult for a franchisor to hide the unfavorable disclosures. I believe there are other reasons the FDD is unreadable.

The first problem is the length. Because so much information is required to be provided, the length of just the basic FDD narrative is typically 50-75 pages of relatively small type. Since the FDD must also include copies of all of the documents to be signed as part of the franchise relationship, as well as specific disclosures required by various states, an FDD will often run to several hundred pages.

The second problem is that the business being offered is more complex. There are a few hundred types, and a few thousand brands, of franchised businesses in the United States alone. There are types of businesses being franchised today relating to products and services which didn't exist fifty years ago.

Moreover, the FDD must contemplate all sorts of franchised arrangements. Area franchising, multi-unit franchising, subfranchising, dual brand franchising, low-end and high-end alternatives for the same basic product or service, multi-national and international options, real estate-based and online store options--all have to be included.

The fact that technology has become a normal part of any business adds to the confusion. Unless someone has a working knowledge of tech language, the FDD will contain all sorts of phrases and acronyms which many will find impossible to comprehend.

Franchisors have, for the most part, done a remarkable job in their efforts to fulfill the requirements of the FDD. However, the purpose of the FDD--the providing of information required to enable the prospective franchisee to make an informed decision--is not served if the FDD is virtually impossible for the average person (or, for that matter, the average attorney, accountant or other advisor) to comprehend. For that reason, we need to change the disclosure process and the FDD.

I can hear franchisors and their attorneys groaning as they read that last sentence. The last thing they want to hear is that another change is in the works--one that is to a large degree not a result of something they have done or failed to do. But a disclosure system begun a half-century ago, a system based upon uniformity and limited alternatives, is of little value in a society of fragmented--if not individualized--opportunities.

----Ken Milner