Required Disclosures - Estimated Initial Investment

By Mario Herman

Individuals looking to purchase a franchise need to be familiar with the Estimated Initial Investment in the Franchise Disclosure Document. This article presents a detailed description of this important item.

As part of its franchise Disclosure Document (FDD), a franchisor is required to disclose to prospective franchisees the franchisee’s estimated initial investment a franchisee will make in the franchise.  The disclosure must be set forth in tabular form, entitled “YOUR ESTIMATED INITIAL INVESTMENT” in capital letters using bold type.  Franchisors may include additional expenditure tables to show expenditure variations caused by differences such as in site location and premises size.  However the table must include the following:  In column 1, the franchisor must list each type of expense, beginning with pre-opening expenses, and including all of the following if applicable: (A) The initial franchise fee; (B) Training expenses; (C) Real property, whether purchased or leased; (D) Equipment, fixtures, other fixed assets, construction, remodeling, leasehold improvements, and decorating costs, whether purchased or leased; (E) Inventory to begin operating; (F) Security deposits, utility deposits, business licenses, and other prepaid expenses.  The franchisor may use footnotes to include remarks, definitions, or caveats thatelaborate on the information in the Table.  Additionally, in the first column, the franchisor must list separately and by name any other specific required payments (for example, additional training, travel, or advertising expenses) that the franchisee must make to begin operations. The franchisor must also disclose in this first column, a category titled ‘‘Additional funds— [initial period]’’ forany other required expenses the franchisee will incur before operations begin and during the initial period of operations. The FTC requires the franchisor to state the initial period, and considers a reasonable initial period to be at least three months or a reasonable period for the industry.   The franchisor is required to describe in general terms the factors, basis, and experience that the franchisor considered or relied upon in formulating the amount required for additional funds.

In a second column the franchisor must state the amount of the payment.  If the amount is unknown, the franchisor is required to use a low-high range based on the franchisor’s current experience.  If real property costs cannot be estimated in a low-high range, the franchisor is required to describe the approximate size of the property and building, and the probable location of the building (for example, strip shopping center, mall, downtown, rural, or highway).

In a third column, the franchisor must disclose the method of payment.  The franchisor must include a fourth column in which it discloses the due date of each payment, and a fifth column in which it discloses to whom each payment will be made. 

The franchisor is required to total the initial investment, incorporating ranges of fees, if used.  And, the franchisor is required in a footnote to state: (i) Whether each payment is nonrefundable,

or describe the circumstances when each payment is refundable; (ii) If the franchisor or an affiliate finances part of the initial investment, the amount that it will finance, the required down payment, the annual interest rate, rate factors, and the estimated loan repayments.

The disclosures required by this section of the Federal Franchise Rule (16 C.F.R. 436) is meant to provide a prospective franchisee with important information regarding the initial investment in the franchised business.  It should be reviewed carefully, with attention being paid to not only the fees and expenses set forth, but to whom such fees are paid, whether they are refundable, and the method the franchisor used to calculate the fees and expenses.  A prospective franchisee will want to compare the information disclosed regarding initial investment with the research the prospective franchisee has done regarding local costs (i.e., rent, utilities, licensing fees, etc.).  Your projected initial investment may be higher or lower depending on circumstances.  An experienced franchise law attorney can assist you in reviewing this table, and can discuss any red flags which you will want to heed. 

Mr. Herman, licensed in Washington, D.C., represents franchisees domestically and internationally in negotiation, mediation, arbitration, and litigation with their franchisors.

mherman@franchise-law.com
www.franchise-law.com
www.internationalfranchiselaw.com
202-686-2886 (ph)