One of the most important elements of researching a franchisor is to thoroughly review the Uniform Franchise Offering Circular (UFOC). The UFOC is an 80+ page document that franchisors are required to give prospective franchisees. The Circular is intended to allow franchisors to disclose important information to franchisees about the franchise opportunity, including the nature of the franchisor-franchisee relationship, the history of the franchisor, and the business and financial requirements for the franchisee. The UFOC is intended to enforce the disclosure of key information about franchisors to protect franchisees from receiving false or incomplete information about the company. Because this document is intended to protect you, it is important that you read the entire Circular carefully, ask the franchisor any questions you might have, and consult an attorney or accountant if you have further questions or are unsure of portions of the Circular. This section is designed to give you an overview of the UFOC so you understand each of the different sections and the areas that should be looked at by legal experts as well. Because some states have specific laws governing the relationships between franchisors and franchisees, parts of the UFOC you receive from a franchisor may be slightly different.

The Franchisor, its Predecessors and Affiliates

The franchisee is you and is referred to "you" throughout the Circular.

The franchisor is the company selling or granting franchises. The franchisor is required to disclose in this section whether the franchisor operates businesses of the type being franchised. In other words, if you decide to open a GasToGo franchise which is owned by the company GasKings, the franchisor (GasKings) must disclose whether the company runs any branches of GasToGo or whether they are all independently operated by franchise owners. The franchisor must also disclose their other business activities, including business ventures the company may be involved in outside of selling these particular franchises.

In this section of the UFOC, the franchisor will also explain the business you will be conducting as a franchisee (i.e., what you will be selling, producing, or providing through your franchise), the general market for the product or service being offered through the franchises, and any regulations specific to the industry in which the franchise is operated. For example, if the franchise you are interested in purchasing collects items such as batteries, ink cartridges, old computers, or something else which requires special disposal, the franchisor must include any specific regulations that may exist in your state involving the disposal of these objects.

Franchisors are also required to state any predecessors within the past ten years. The predecessor means a person from whom the franchisor acquired directly or indirectly the major portion of the franchisor's assets. As an example, suppose you decide to purchase a Lick's Ice Cream franchise. Lick's is owned by Haskell Brands, Inc., who also operates sandwich franchises, pizza franchises, and seafood franchises. Haskell's began selling Lick's Ice Cream stores after acquiring Lick's Ice Cream Company. Lick's Ice Cream Company no longer exists, even though the franchises are still sold, and Lick's Ice Cream Company is considered a predecessor of Haskell Brands, Inc. Why is it important to understand the history of predecessors to your franchise? Suppose Lick's Ice Cream Company went bankrupt and all of their franchises failed? It could be because of poor management, but it could be because of a poor business idea. The history of the predecessor is less relevant as time passes, but if it was a recent company acquisition, problems could still exist that might plague your business.

An affiliate means a person controlled by, controlling, or under common control with the franchisor, which is offering franchises in any line of business or is providing products or services to the franchisees or the franchisor. For example, Lick's Ice Cream stores are owned by Haskell Brands. In each of these stores, they sell candy from another company, Candy Mayhem. The franchisor is Haskell Brands, and the affiliate is Candy Mayhem. Because the affiliate has an agreement with the franchisor in all of their stores, all franchises are required to purchase and sell candy from Candy Mayhem as well. Candy Mayhem may charge premium prices for their candy, and as a result Lick's Ice Cream franchises might see steep candy costs that would not exist with other cheaper suppliers. Nevertheless, by the contract, they are required to use Candy Mayhem. This cost of doing business is an important reason why franchisees must understand who all of the affiliate partners are and what the requirements are with regard to the affiliates.

Some other items the franchisor is required to disclose in this section include the business experience of the franchisor, its predecessors, and its affiliates; the length of time the franchisor, each predecessor and each affiliate has conducted business of the type to be operated by the franchisee; the length of time the franchisor has sold franchises of the type to be operated by the franchisee; and whether the franchisor has offered franchises in other lines of business. If so, the franchisor must describe each other line of business, state the number of franchises sold in each other line of business, and state the length of time the franchisor has offered each other franchise.

Business Experience

The franchisor is responsible for listing the names and positions of all directors, trustees and general partners, principal officers, and other executives who will have management responsibility over the franchises offered by the company. Why is this information important to you? In addition to their current position, the UFOC will also list previous positions held by these individuals. It is important that the franchisor company demonstrates solid management history. For example, if the current President of Haskell Brands is listed as Mitch Stevens, who was previously President of Save-A-Lot, a national discount franchise store chain that has been growing successfully, you can trust that the company is run by an experienced executive with a successful track record of managing franchisor companies. However, if Mitch Stevens is listed as the previous President of Tuna Mart, a national chain of franchises that sold nothing but tuna products and quickly failed and declared bankruptcy, you may not be completely confident in his ability to successfully run Haskell Brands. Tuna Mart may have failed because of his leadership, or it may have failed because it was a poor business concept. It is important then to look to the other leaders of the company listed in the UFOC to see if they bring strong management experience to the company.

Litigation

The franchisor is required to disclose whether the franchisor, its predecessors, or any affiliate has any administrative, criminal, or material civil action pending against them or if they are subject to any currently effective injunctive. In addition to current or pending actions against them, the franchisor must disclose if the franchisor, predecessors, or affiliates have ever been convicted of a gelony or pleaded no contest to a felony charge in the ten years prior to the publication of the UFOC.

This is an important section to read and understand because it may reveal potential warning signs about the franchisor. If a company is clean and has never been involved in any litigation, this section will simply say that no litigation is required to be disclosed in the offering circular. If, however, the company has been sued or involved in other legal battles, they will be listed with the name of the opposing party, the matter of the lawsuit, and the conclusion of the case. Even if litigation is mentioned in the UFOC, it may not be negative toward the company. Looking at the details of the case will give you a better understanding of who was at fault.

For example, if Haskell Brands sued one of its franchisees for selling unapproved products, using alternate suppliers, and not following the terms of the franchise agreement, this is most likely not a negative statement against the franchisor. Especially if the court found in favor of the franchisor (meaning that the franchisee was in fact at fault). If, however, Haskell Brands was sued for disclosing false earnings statements and performing other unlawful acts to sell additional franchises, you may want to be wary. If the court found against the company, and Haskell Brands was in fact guilty of doing this, look to see how long ago the action was and whether they have had a clean record since then.

Bankruptcy

This section will state whether the franchise or any predecessor or affiliate has within the past ten years filed for bankruptcy or obtained a discharge of its debts under the bankruptcy code. It will also inform you whether any person with management responsibility over the franchise has ever been involved in a company or partnership that filed bankruptcy. If neither the company nor any person involved in the company has filed for bankruptcy, this section of the UFOC will state that no person previously identified has been involved as a debtor in proceedings under the US Bankruptcy Code required to be disclosed at ths time.

If the company has filed for bankruptcy, it may say that the company has reorganized under Chapter 11 of the U.S. Bankruptcy Code and thus avoided bankruptcy. If this is the case, it is important to note how long ago the Chapter 11 filing was to guage how long the finances of the company have been stable. Make sure you have a financial expert carefully look over the financial statements of the company to ensure that they are not on the verge of filing for bankruptcy a second time. Be cautious in getting involved in a venture that is struggling financially. If the company loses everything and is forced to dissolve, your business will go down with it as well.

Initial Franchise Fee

This is the first fee covered by the UFOC in the cost of a franchise. Franchisors are required to disclose the total amount of the franchise fee as well as the conditions by which this fee is refundable. The initial franchise fee includes all fees and payments for services or goods received from the franchisor before the franchisee's business opens, including licensing fees, intial training and marketing, and other up front assistance. It is important to find out what fees are included in the initial fee to avoid paying for them later. Not all initial fees are required to be paid in lump sum. Many franchisors will allow installment payments over the course of a year or so, and this will be spelled out in the UFOC. this section will also include the terms for refunding the franchise fee. Why is this important? There are several common circumstances in which you might require a refund, including if your franchise application is declined for one reason or another, or if you are unable to complete your training. By knowing the terms of your franchise fee in advance, you can not only save money later on by avoiding hidden costs but you can get your money back if you don't go ahead with the franchise purchase.

How much are typical franchise fees? Although they vary, franchise fees generally fall anywhere in the range of $15,000 to $50,000. Newer franchises may have lower franchise fees than more established franchises, but franchise fees may vary for other reasons as well. Higher prices does not necessariy mean a better franchise, so don't judge the value of a franchise by this fee alone.

Other Fees

In addition to the initial franchise fee, franchisors are required to disclose the other costs you will be required to pay over the duration of your franchise ownership. These can include recurring costs such as royalty fees or one-time costs such as a transfer fee, which is required when you sell the franchise. Along with a description of each fee and the amount, the franchisor will state the due dates for payments, any exceptions to the fees, and if any of the fees are non-refundable, and to whom the fees are payable (some fees may go straight to the franchisor, while others will be paid to an affiliate, for example). Some of the fees that may be described in this section include:

Royalties (usually between 4% and 10% of total gross sales paid monthly)
Lease negotiation
Construction
Remodeling
Additional training (usually a cost per person)
Advertising (oftentimes a percentage of total gross sales in addition to royalties)
Group advertising (oftentimes a percentage of total gross sales in addition to royalties)
Additional support and assistance (usually a cost per day of support or assistance)
Audit
Accounting/inventory
Transfer (a single lump sum due when you sell the franchise)
Renewal (a single lump sum due upon renewal of your contract)

These fees are important because they are the cost of doing business. Although many prospective franchisees evaluate only the initial franchise fee, these are the fees that you will have to pay for the duration of your business ownership experience. Fees such as royalties and advertising fees are paid directly as a percentage of your profits each month. Even before your business becomes profitable, however, you will still need to have the working capital to pay ongoing advertising fees and other business costs, so be sure and factor those into the amount of capital you have available.

Initial Investment

In addition to the initial franchise fee and other fees associated with the ownership and operation of the franchise, the franchisor is required to disclose an estimate of the initial investment required. In the UFOC, the franchisor must state what expenditures are expected, to whom the payments are made, the payment schedules, whether any of the payments are refundable, and if there are any financing options available for the total initial investment. The costs associated with a franchisee's initial investment, like the franchise fee, are those fees required before the business opens; unlike the franchise fee, however, these costs are generally not paid through the franchisor and are not related to direct services received from the franchisor. These costs can include, but are not limited to, property/real estate, equipment, construction, remodeling, initial inventory, utilities, business licenses, and other prepaid expenses. The initial investment can vary widely among franchises. A home-based business, for example, does not have the high cost of purchasing or leasing land or a building for office space. On the other hand, some franchises require large buildings and large lots, including expensive equipment and machinery.

In addition to these costs, the initial investment may also include practical expenses such as travel and living expenses while training. these can include airline trips to training locations, hotel expenses, meals and incidentals. Because training can last several weeks, these costs can be as high as $5,000 to $10,000 and are generally not covered by the franchisor.

Last, the franchisor will make sure the franchisee has enough working capital to operate the business without revenues for as long as it is expected to take until revenues cover all expenses. For some franchises, this can be as little as three to six months, but many franchisors require up to three years in working capital. This can add up significantly toward the total initial investment. The benefit of having multiple years in working capital available is the knowledge that the franchise will be sustained for at least that long. Even if the development of new business is slow, the franchisee will be able to continue operating his or her business and continue investing in advertising, training, and more.

Restrictions on Sources of Products and Services

This section explains the obligations you have as the franchisee to purchase or lease specific products and services from the franchisor or from any of the suppliers approved by the franchisor. Even though you know of a local supplier who sells quality machine parts at cost, you may be required to buy your parts from an approved vendor or an affiliate of the franchisor at a higher price. Some of the obligations described in this section include restrictions on the purchase of equipment or items related to establishing or operating the business and any approved suppliers required by the franchisor. The franchisor must disclose whether they derive revenue as a result of the required purchases or leases and what percentage of the total estimated purchases or leases are required or regulated.

For example, if you run a Coffee World coffee store franchise, and you are required to purchase all of your pastries, coffee beans, and cups from approved suppliers, the franchisor must disclose that a very high percentage (if not all!) of your purcashes are regulated. In addition, they may have special agreements with the pastry suppliers that state that they earn revenue off of the purchases made my their franchisees. Although this might not be a problem, it may mean higher fees on supplies for your business, and you should be aware of how much money your franchisor is making off of your purchases.

Franchisee's Obligations

The franchisor must list all of the obligations of the franchisee related to the acquisition and operation of the franchise from site selection to dispute resolution to contract termination or renewal. This is a critical section of the UFOC that must be thoroughly read and understood by all franchisees to ensure they know right away with their responsibilities will be as franchisees. It is highly recommended that you have an attorney or other legal representative review this section of the UFOC to make sure there are no obligations you are required to fulfill that are unreasonable.

Franchisor's Obligations

Just as the franchisee has obligations, so too does the franchisor. The franchisor's obligations include both their duties before your business opens as well as their responsibilities that must be met during the operation of your business. Pre-opening obligations can include assisting you in the location of a site and negotiating the purchase or lease of the site, hiring and training employees, and assisting in the purchase or lease of equipment and supplies. Suring the operation of the business, the franchisor's responsibilities can include overall assistance with management, administration, and advertising.

This section will go into further detail about the obligations of the franchisor, including the methods used by the franchisor to select the location for the franchisee's business and the specific training program offered by the franchisor. You should carefully review this section to understand what the franchisor is guaranteeing you in terms of support, training, and marketing assistance. If the franchisor doesn't list adequate requirements and obligations on their end, you should be wary of what you will receive for your money.

Territory

Understanding your terriroty and your territorial rights is an important way to protect your franchise. In this part of the UFOC, the franchisor must describe the exclusive territory granted to you as the franchisee, in addition to whether the franchisor has established or may establish another franchise, company-owned outlet, or other entity operating under the same trademark may open within that territory. Beyond that, the franchisor must disclose if franchises or outlets selling similar products or services under a different trademark are permitted to operate within that territory. Pay particular attention to disclosures regarding your territorial exclusivity and under what circumstances the territory may be altered, as this can hurt your business down the road if you are not careful. Things to watch for include a length of time after which your territory may be renegotiated or the change in territorial rights you may encounter in the event of a merger, acquisition, or other company change.

For example, suppose you owned a Lick's Ice Cream store under the company Lick's Ice Cream Company. When the company filed for bankruptcy, they were purchased by Haskell Brands and Lick's Company became the predecessor. Your contract as a Lick's franchisee should stipulate what would happen in the instance of an acquisition; otherwise, Haskell Brands might have the right to put a new store under their own name directly across the street from your Lick's store within your previously protected territory.

Trademarks

This section will identify all of the trademarks, service marks, names, logos, and symbols belonging to the franchisor and the rights of the franchisee to use such trademarks. In addition, the franchisor is also required to disclose, in addition to the rights of the franchisee, any factors that could potentially affect the franchisee's ability to use these trademarks in the state in which the franchise is to be located. An example could be a trademark that is rejected by the U.S. Patent Office for being too similar to an existing trademark belong to another company or other similar reason. In that case, some franchisees (not in areas affected by the patented trademark) might be able to use it, while others in particular territories would not.

Patents, Copyrights, and Proprietary Information

In addition to trademarks, the UFOC will identify any patents or copyrights owned by the franchisor that are relevant to the franchise. In addition, the franchisor must state whether there are any agreements, current determinations, or infringements related to patents or copyrights that could somehow affect the franchisee and the franchisee's ability to do business. For example, certain proprietary information may be approved for your use, but may have restrictions to protect the information.

Obligation to Participate in the Actual Operation of the Franchise

Although this is often overlooked by prospective franchisees, one important thing to consider when looking at different franchise companies is the obligation of the franchisee to participate in the actual operation of the franchise. That means that, in addition to operating the franchise and handling overall ownership responsibilities, the franchisee must be on the premises of the business during times of operation. Although this is not always a requirement, it is usually recommended. For those franchisors who do not require personal on-premises participation by franchisees, they often pose limitations on who the franchisee can hire as an on-premises manager and require that person to complete training by the franchisor at the franchisee's cost.

Restrictions on What the Franchisee Can Sell

Planning on opening a furniture store franchise featuring your own new line of trendy, sophisticated, designed-by-you furniture? You might want to read this section of the UFOC first, which explains the restrictions on franchises to sell the goods and services to customers that are outlined in the disclosure statement. The franchisor will state the limitations on franchisees' rights to make changes to products and marketing materials and more. In fact, one of the primary reasons franchises fail is because they fail to abide by these restrictions and don't follow the established system. These restrictions are important, because the products and services you sell must be tailored to your market audience. The limitations will prevent you from altering them to fit your region most of the time, so they must be suitable as is. In addition, if you cannot get behind the goods and services offered by the franchisor, you will have a difficult time selling them to customers. These restrictions are important for franchisors because they guarantee a consistency in the products and services offered by franchisees around the country.

Renewal, Termination, Transfer and Dispute Resolution

This is an important section in defining the nature of the franchisor-franchisee relationship, as it covers everything from renewal to termination as well as what happens when you have a dispute with the franchisor. Here, the franchisor must state the length of the term of the franchise agreement, and the terms by which the franchisee may renew the contract at the end of the term. This will be accompanied by an explanation of the requirements for renewal and the fees for renewing. For franchisees who do not wish to renew or who are not allowed to renew by the franchisor, this section will also include the conditions by which you or the franchisor may terminate the agreement and what obligations or fees the franchisee will incur in the event of a termination.

The third option, in addition to renewing or terminating the contract, is to sell the franchise. Some contracts make it difficult for franchisees to sell or transfer the franchise, and this section should be reviewed carefully and by an attorney as well. Included here will be the rights of a franchisee to sell or transfer, what approval is required from the franchisor in advance, and the rights of the franchisor should the franchisee choose to sell. Oftentimes franchisors will include clauses stating the right of first refusal, meaning that they must have the opportunity to purchase the franchise back from the franchisee before the franchisee can entertain outside offers. The clause by which you are allowed to sell your franchise is important because it may mean less money for you when you decide to sell. Take note of the transfer fee as well as the rights of the franchisor. If they have the right to buy your franchise from you directly, what price do you have the right to receive?

Public Figures

Public figures are those persons who are compensated for their role in endorsing or advertising the franchise. Do you have a famous movie star telling people to eat at your franchise, or is a well-known sports star promoting your energy products? Those individuals are public figures and will be listed in this section of the Circular. In addition, the franchisor must state whether the public figure has any role in the management or control of the franchise and how much compensation is paid or promised to the individual in return for his or her endorsement.

While you may want a famous star advertising your products because you believe it is good for your business, you may think the fees being paid to this person are too high. Remember that a portion of your profits are going to this person's salary as spokesperson for your product. It is important to look at the costs being spent on public figures to determine if they are worth it to your business.

Earnings Claim

The earnings claim is an estimate of the actual or potential sales and revenue that a franchisee can enjoy. These potential earnings are described in a chart that shows possible results based on a combination of factors including the price and quantity of sales. With this chart, franchisors are responsible for proving a reasonable basis for their earnings claims.

Although the primary thing most franchisees want to know is "how much money am I going to make", franchisors are not required to disclose estimated earnings. For those franchisors who do not, they are required to file a negative disclosure form which states that a franchisor does not estimate what the results of any particular franchise might be as results vary widely across all units. So how do you find out what type of earnings you can expect in this case? Talk to current franchise owners and get the real deal about their costs, revenues, and profits. Find out how long it took them to break even, and find out if their profits have continued to climb. The next section of the UFOC will provide you with all of the information you need to contact other owners in your franchise.

List of Outlets

The list of outlets will provide you information on other franchise outlets, owners, and franchise track records within the company. The Circular will provide you with the total number of franchises owned or operated over the past three years, including the names of all of the franchisees, their phone numbers, and their addresses. You will find out how many franchises have been sold or are expected to be sold in the next year, and how many franchises have been transferred, terminated, reacquired by the franchisor, not renewed, or for some other reason have ceased doing business sometime over the past three years.It is important that you speak not only to current franchisees, but to franchisees whose stores have been terminated or transferred if you can get ahold of them. You may not get the whole story from some owners, so it is important to speak with individuals who have had different experiences working with the franchisor to get different perspectives on the level of satisfaction with the franchise experience.

What type of questions should you ask current or past franchisees? Find out their overall level of satisfaction with the franchisor, including whether they received enough support before opening the franchise and during the operation of the franchise. Ask whether they felt the training they received adequately prepared them for the successful operation of the franchise business, and if there was any training they had not received that they wish they had. Ask if they were prepared financially, if they received financing from the franchisor, how long it took until they were generating profits, and whether their profit levels were similar to those stated in the Circular, if applicable. Ask franchisees located near you or in areas similar to yours whether you can spend a day with them on the premises of their business to learn what the day to day management of the store is like. Try to visit with more than one store to get a feel for average duties, issues that may arise, and business flow on several different days.

Financial Statements

The financial statements offered in this section of the Circular will include a balance sheet for the most recent fiscal year, an income statement, and any changes in the financial position of the franchisor over the past three fiscal years. If you don't understand how to read these documents or what these documents mean, ask an accountant or other financial consultant to help you understand the state of the franchisor's financials. How much will this cost you? Hiring an accountant to review their financial statements can cost anywhere from a couple hundred dollars to a couple thousand dollars, but will pay itself back tenfold if the accountant uncovers negative financial statements or warning signs that could affect your business. Even if you do not hire an accountant to look over the financial documents, it is important that you check their financial claims and earnings statements if they make them. Remember, even though the franchisor is required to submit financial statements to prospective franchisees, the government does not verify whether the information provided is correct, misleading, or inaccurate. It is up to you to do your homework and make sure you understand everything the franchisor is offering or not offering to franchisees.

Contracts

Within the UFOC, the franchisor is required to attach all proposed franchise contracts, including the franchise purchase agreement, leases, options, and other binding documents. This is your chance to review these documents in advance with an attorney or other legal expert knowledgeable in franchise agreements. These contracts are binding legal commitments that you must fully understand before signing anything or writing out any checks to the franchisor.

The documents are generally divided into two parts: the purchase agreement and the franchise agreement. The purchase agreement refers to the up-front purchase of the franchise including the initial franchise fee and all other immediate financial obligations, the equipment and supplies you will receive at the beginning of your relationship with the franchisor, and the services the franchisor will provide to you at the launch of your business venture. The franchise agreement, on the other hand, explains the relationship between the franchisee and the franchisor beyond the initial phase of the franchise. This includes ongoing fees and expenses, operational support and assistance provided by the franchisor, and the restrictions, rights, and obligations of both the franchisee and the franchisor.

The franchise contracts will define your relationship with the franchisor from the time you sign the purchase agreement to the time you sell your franchise or terminate your relationship with the franchisor. Make sure you clearly understand what is required of you during the operation of the franchise and what is required of the franchisor as well. If you have any questions, ask!

Remember, even if you think you have a solid understanding of what to look for in the UFOC, it is highly recommended that you hire an attorney and an accountant to help you review the contracts and financial obligations from a legal perspective. A franchise is a major investment of your time and your money, and the proper legal advice will make sure you know exactly what you are investing in.