Do you want to have absentee owners, or do you want your franchisees running the business as the manager of that franchise business? Even if the franchisee is not on-site, are you going to require a manager? Would this manager need to be approved and go through the initial training with the franchisor? Item 15 is where you make these disclosures.
Best Practice
For startup franchisors, and really most franchisors, we believe they should require their franchisees to participate in the business. Franchising is not only about obtaining the financial capital from the franchisee; it is about getting the right human capital to run the business that separates the winners from the losers. So even if they’re not in the store every day, you should require direct management and make it an obligation to participate in the business. The franchisee should be responsible as they are taking an enormous business risk, and so are you by trusting your brand standards with the franchisee.
While franchising is a business about human capital, there are certain concepts where the investment is so high that a franchisee may have other people invest with them, such as friends and family who will be passive investors. But a significant issue with having a passive investor is that the franchisor needs to have a relationship with the franchisee, and if the franchisee is a passive investor, that franchisee is not involved. They might have managers, but the franchisor doesn’t have a relationship with the manager, and this really speaks towards accountability. If you are going to hold your franchisee accountable for brand standards, paying bills, and growing the business, and they’re not participating in the actual operation, you will have difficulty holding them accountable. You should create the expectation that they should be participating and responsible for running the business. It could be as simple as monthly board meetings. The key is that you’re going to hold the franchisee accountable and you need to communicate that before you award them a franchise.
Entity
Your franchisee will probably want to use an entity to act as the franchisee for various tax and liability protection reasons. Still, our standard is that the individual also signs the franchise agreement personally. Those valid liability protections are meant to protect the franchisee from the general public and vendors, not giving them an out on their responsibilities to you as their franchisor. Because we require them to sign on as an additional franchisee personally, they don’t have to sign a personal guarantee which is normally disclosed here in Item 15. However, we do expect the franchisee’s spouse to sign a spouse guarantee, and we will disclose that in Item 15. This is an area where you might get pushback from new franchisees, and when the time comes, we will advise you that some flexibility here is normal. The most important part is that the spouse recognizes that they are under confidentiality and non-compete agreements, even if you are willing to waive the financial responsibility in limited situations.
Sample Item 15-1
ITEM 15: OBLIGATION TO PARTICIPATE IN THE ACTUAL OPERATION OF THE FRANCHISE BUSINESS
If you are an individual, you must directly supervise the franchised business on its premises. If you are a corporation, a person who owns at least a 1/3 share of the corporate equity must perform the direct, on-site supervision of the franchised business.
This is a sample section from a fictional FDD for Belmont Muffler Shops that was prepared by the Federal Trade Commission as a compliance guide for franchisors preparing their FDD. These are used to provide an idea of what these items may look like in an FDD, but keep in mind, your FDD will most likely vary significantly from these examples.
Sample Item 15-2
ITEM 15: OBLIGATION TO PARTICIPATE IN THE ACTUAL OPERATION OF THE FRANCHISE BUSINESS
We do not require that you personally supervise the franchised business, but we do recommend it.
In any case, the business must be directly supervised “on premises” by a manager who has successfully completed our training program. The on-premises manager cannot have an interest or business relationship with any of Belmont’s business competitors. If the franchisee is a corporation or a partnership, the manager need not have an ownership interest in it. The manager must sign a written agreement (Exhibit G) to maintain confidentiality of the trade secrets described in Item 14 and to conform with the covenants not to compete described in Item 17.
This is a sample section from a fictional FDD for Belmont Muffler Shops that was prepared by the Federal Trade Commission as a compliance guide for franchisors preparing their FDD. These are used to provide an idea of what these items may look like in an FDD, but keep in mind, your FDD will most likely vary significantly from these examples.
