Mark Vandegrift
Welcome to the latest episode of FranSimple, the podcast designed to make the concepts of franchising simple. I'm your host, Mark Vandegrift, and with me is my franchise bro and an all-time expert on franchising, Steve Vandegrift. Steve, welcome.

Steve Vandegrift 
Thanks Mark, great to be here.

Mark Vandegrift 
Well, we covered some basics in the last two episodes, but I want to kind of go back to the basics with a new client. And as you engage with a new client and they're facing what I would call a decent amount of work to gather the detail that makes up a business system, I want to get from you maybe a little advice that you might give them. So when you begin with a new client, you typically have them start by protecting their IP, which we covered on the last episode. So the next step, I believe, is the franchise disclosure document or what we call the FDD. Can you maybe explain what the FDD is in very simple terms?

Steve Vandegrift 
Sure. The franchise disclosure document actually is the mechanism by which companies can begin offering franchises. The franchise disclosure document is actually mandated by the Federal Trade Commission under what's called the FTC franchise rule. And that requirement basically stipulates that franchisors must prepare a compliant FTC compliant franchise disclosure document. Many people, you know, they haven't reviewed a franchise disclosure document previously. They think of a single document. The franchise disclosure document is that. It's a single document, but it holds a number of different documents. The first is really the 23 item disclosure. These are 23 items every franchisor has to disclose. But in addition to that, there's a number of other agreements and exhibits and attachments to a franchise disclosure document. So ultimately, two of the agreements certainly would be the single unit franchise agreement and then the area development agreement, which basically provides an area developer the right to open a specified number of franchises within a area development territory that's mutually determined by the area developer and the franchisor. And then other exhibits are part and parcel to the franchise disclosure document. There's required disclosures for financial statements, a table of contents to your operations manuals, and other similar documentation.

Mark Vandegrift 
Okay, so it sounds like there's a lot in the FDD, but in essence, it is a single document that the FTC requires to be able to offer franchises to those that are interested. So there's other business expansion methods, right? I can open a corporate place or I can do dealers or I can do distributorships. Why does the FTC require an FDD? And yet with all those other business ways of expansion, they don't require anything special for those different types of businesses.

Steve Vandegrift 
Well, that's a great question. The reality is the Federal Trade Commission did businesses a great favor when they basically broke out this FTC franchise rule. Without that basically breakout, it would be considered a securities and subject to the SEC. So it really did reduce the burden to franchisors while still enabling them to expand. And it's really one of the best methods of expansion outside of corporate expansion. And we could certainly sit here and maybe one of a future podcast, we'll get into the advantage of corporate expansion versus franchise expansion. But ultimately that franchise disclosure document is truly the one mechanism that is required of all franchisors. And again, it begins with that 23 item disclosure and then all the other ancillary agreements, exhibits and attachments.

Mark Vandegrift
So if a franchisor were to just fill out the FTD and get it applied and accepted, that would be the only document they would need to sell a franchise or to offer a franchise.

Steve Vandegrift 
And theoretically, that's correct. Now, there are a number of states in the country that require franchisors to actually register with the state before they're permitted to offer or grant franchises within that state. There's actually 14. There's a handful of other states that require franchisors that do not have a federally protected trademark to comply. It may be registering under their business opportunity laws, et cetera. So there are a number of states in the country that in addition to the FTC franchise rule, they have certain regulations and requirements for franchise companies that want to offer and grant franchises in their state.

Mark Vandegrift 
Okay. So really it's not as complex as one might think. You mentioned a lot of components to the FDD, but I know  you lead clients through that process to make it really pretty digestible. You know, they say, if you're going to eat an elephant, do it one bite at a time. You're helping them eat one bite at a time. So, given that what's typically the very first task that you have a franchisor do when you begin the development of the FTD.

Steve Vandegrift 
Well, and actually we begin the first step. We do extensive research when we first onboard a client. We're basically researching other similar concepts. We really want the client to have a very good understanding of what there would be competitors are doing. So that relates to things like their franchise fees, their initial investments, their royalty fees, brand fund fees. We really take a deep dive and we produce what typically is 100, 120 page report. And we do that for a couple reasons. Number one, most of our clients have never been a franchisor. And in many cases, they've never reviewed a franchise disclosure document. So we want them to have a basis for why we recommend certain fees, certain territory criteria, et cetera. And so we use that as we're assisting them in preparing the information that our preferred attorneys need in order to draft that franchise disclosure document. We do that through proprietary questionnaires that we've developed that really help us walk a client through each and every provision term, required disclosure, et cetera, that's required under that FTC franchise rule. And we'll actually make recommendations as to what they may want to consider for all of those various components, whether it's the franchise fees, the other fees, the territories. There's other aspects, the financial performance representations where they're allowed to make financial, they're allowed to share financial information with prospective franchisees. So those questionnaires really help our clients that say stay on point as we're going through the various items first in the FDD and then the terms and provisions of the franchise agreement, which we call the franchise relationship, the relationship between the franchisee and the franchisor.

Mark Vandegrift 
Okay, so what is the first task that you have them do after you do the research?

Steve Vandegrift 
Great question. So we actually do send our clients that questionnaire. We expect maybe them to complete 15 or 20 percent, whether they're going to form a new legal entity, which we always recommend to clients. And 99.9%, their CPA, their business attorney agrees that that's a good strategy. And so we're really looking at helping them understand how do all of these various components fit together. And so we'll send them that FDD so that they can give us their high level thoughts. Some clients will actually fill in I think maybe our franchise fees should be this or our royalty fees should be that and sometimes they're very point-on. They have a great understanding of franchising. It certainly fits within their industry within their category. Other cases we obviously have to recommend a client not maybe charge $100,000 franchise fee upfront when the average in their industry may be $40,000. Same thing with franchise royalties, etc. And so they'll basically provide us their high level thoughts. And then we begin conducting a series of web meetings with our clients to literally start going through it from the very beginning, clear through the last questionnaire. And through that, our attorneys are then able to obviously begin drafting that document. Our attorneys oftentimes will be involved in a couple of those web meetings as we're getting into specifics relative to their business, questions that they might have that might be different than a typical franchisor and we figure out how to make what they would like to do meet the legal definition of a franchise. And so at that point, every client's a little different. Like I say, generally, we can get through that questionnaire process during about the first three weeks. Now, of course, that comes down to our client's ability to engage with us on a regular basis. We have some clients that come to us they're operating 20, 25 locations. Their time is a little more limited. We have other clients that really they're open to this. They have a great management team and staff that's managing their two, three, four, five locations. And so they're able to devote the necessary time.

Mark Vandegrift 
So you mentioned all these items that are in the FTD. One, and just very simply, why are they called items? Is that a legal reference? And two, maybe give us a sense of what some of the items are and how a lot of times they're answered.

Steve Vandegrift 
Sure. Basically, the 23 item disclosure that begins the franchise disclosure document, every franchisor is required to answer them. And some are very, very simple. So as an example, item two is the bios of the owners, the officers, the directors. Items three and four relate to any litigation or bankruptcy against either the company itself or the owner's officers that would have a material effect potentially on the franchise. As we get a little bit deeper, item five is all about the initial fees. And what's interesting, many of our clients, they think, okay, I have a franchise fee. That's what's going to be disclosed. Well, they're right. But in addition, let's say they're going to sell them a startup package of various small wares or various branded items, you know, logo to peril and things like that. Any payment that's made to the franchisor or an affiliate of the franchisor, is required to be disclosed in that item five. So for some of our clients, we have a client as an example that actually owns a restaurant equipment company and they're a required supplier. And so ultimately we have to disclose what that initial equipment package is going to cost, the payment terms, et cetera. Item six is all about the fees, brand fund fees, royalty fees, et cetera. Any fee that the franchisee may pay to us, to the franchisor or their affiliate company. Item seven is an initial investment chart. And that's one, both item six and item seven, you can imagine, we're really advising our clients quite a bit. It's a line item. Item seven is a line item list of all the costs and expenses that the franchisor anticipates they're going to incur as part of the develop of their location, as well as typically through the first few months of operation, kind of a ramp up period. So the item seven, well, actually the bottom line item, we include a working capital. Kind of like to cover any additional expenses that maybe they didn't see, maybe to help them get through that ramp up period, et cetera. Item eight is about suppliers. You have to disclose approved and designated suppliers. Franchise prospects need to know exactly who they're required to purchase from. We get a little bit further into it. Item 11 is all about the various support training services that the franchisor is going to provide. And within that item 11, there's actually, in essence, a training itinerary. Once again, a line item chart that outlines each and every topic that's going to be covered, whether the number of hours of on-the-job training or classroom training. And classroom training certainly includes web meetings, online communication, et cetera. And then we also have to disclose where is that piece of training taking place or that part of training. So is it at the corporate office, one of the franchisors' corporate locations? Is it going to be conducted at the franchisee's location? A couple other major items would include certainly the item 19, and that's what's called the financial performance representation. Prior to 2008 when the FTC updated the rule, was called earnings claims. Well, financial performance representations can take many different forms. We have clients that will simply provide the last couple years of profit and loss statements for their locations. You can actually aggregate that. In other words, take all of your location, the numbers and divide it by the number of locations you have. You can disclose it individually. That is obviously a very important item for prospective franchisees to get their arms around the financial metrics of the business itself. Item 21, franchisors are required to provide financial statements for their franchise company. If they have formed an affiliate company to be the franchisor, that's the only company that has to provide financial statements. As a startup franchisor, the FTC permits franchisors, there are a few states that they don't allow this, but it's basically phasing in over a three-year period the audited financial statement requirements. So the first year or partial year of franchising, most of our clients simply need to prepare an unaudited balance sheet. Now going into year two, they have to audit that balance sheet for year one and then provide unaudited all the other financial statements, statement of operations, statement of cash flows, shareholders equity. Going into year three, they have to go back and they audit the second year, all the financial statements. And from that point forward, they have to annually audit all of their financial statements and include three years once they get to that point of audited financial statements in that 23 item disclosure, item 21. So those are a handful of the key ones.

Mark Vandegrift 
Okay, you got a lot of items there. In your 30 plus years of dealing with franchising and setting up franchises and doing franchise development, do you find that there's a certain one of these that most franchisors get hung up with that are the hardest for them to work through? Because I would think doing bios is pretty easy.

Steve Vandegrift 
Correct.

Mark Vandegrift
Or doing something like, you know, giving you financial statements, because what are you going to do with financial statements other than the way that you present them? They have to be true and, and I think audited.

Steve Vandegrift
Prepared according to Gath.

Mark Vandegrift 
So at that point in time, what are the ones that maybe just one that folks get hung up on and that we might be able to prepare a new client to say, okay, of all the things you have to think about, think about this one thing, because that's where the sticking point tends to be.

Steve Vandegrift
Well, I can certainly point out maybe three different ones. Item seven, the initial investment chart. Sometimes we have clients that haven't opened a location in a few years. And so we'll make a recommendation. Let's just say it's a restaurant or retail store that they actually talk to their equipment supplier and get updated quotes. And so for many of our clients, that's something that they need our kind of guidance, advice, et cetera. Item 19 is another one. And even the financial statements, many of our clients, their CPA may not have previous franchise experience. So I'll do web meetings with the client and with their CPA, kind of walk them through what that disclosure looks like. Especially item 19. Again, you'd think it's pretty clear cut, but franchisors could simply elect just to provide gross sales or they can do a detailed profit and loss statement. There's all kinds of metrics that you're allowed to disclose. And we like to say with the financial disclosure, our attorneys always say as long as you disclose it, and it's historical and inaccurate, you can include it. So you could actually include in there how much of your business is repeat customers. If our clients have that metric and they want to disclose it because they feel prospective franchisees will ask, that's another thing that can go into that item 19. So those couple of items are certainly ones that really we have to educate. And we do consider education a huge part of what we do with our clients. We like to say that kind of the initial process before we engage, they're going to end up getting an associate's degree in franchising. And as we go through the process, they're probably going to have a bachelor coming out of it. And then as they begin operating, all of a sudden, all the pieces are coming together. And now they have their masters in franchising. And that's really our goal with every client. We really want them to take ownership of that franchise disclosure document. That's the basis to form the legal relationship with a franchisee.And it's very important when they're talking to franchisees that they can address the question, well, why did you do this? Or why is the fee that? And so we really make sure that our clients have great understanding of exactly all of those terms, provisions, and disclosures that are included in that franchise disclosure document.

Mark Vandegrift
So you had mentioned that I think you used the word weeks, that you can get this done in a matter of weeks and that's assuming that the franchisor has most of their information gathered. A lot of times what we have found is that a lot of business concepts just work with a, and I'm going to put in air quotes, franchise attorney to complete an FDD, but we find that either the franchise attorney isn't really a franchise attorney and instead is trying to play one on TV and that fails at many points. From the perspective of the legal preparation, how does FranSource smooth the path to the completion of the FDD?

Steve Vandegrift 
Well, you're exactly right when you say that legally the franchise disclosure document is the one document that's required. Now there's all these other pieces and parts to developing a robust franchise operation. None the least is certainly the franchise operations and policy manual. We assist clients in developing their entire franchise sales development system, et cetera. And so all of those come together and all have an impact on the ultimate outcome of their success or not success. We have found that, again, as you mentioned, well-meaning business attorneys will want to draft or we have a number of clients every year that worked with another company and they receive their franchise disclosure document and they're reading it. They're reading their operations manual and the most common phrase and they say it different ways is, I don't even recognize my business in these documents. What do we do? And typically what has happened is their attorney took an FDD that was for a different industry and tried to convert it into their industry. With the operations manual, the other companies would end up basically using a lot of fluff and there really wasn't operational procedures and standards and policies. In fact, when we do work with these existing franchisors and they ask us, would you help us redo our operations manual or we don't even have a franchise sales development system. With the operations manual, we'll actually ask them to provide us a copy of their franchise disclosure document. And they're always, we'll send that, we're fine with that, but I'm curious, why do you need to review it? And we explain that the attorneys will cross reference the franchise operations manual many times in the legal document. Otherwise, you'd end up with a four or 500 page agreement rather than a 60 page agreement. And so we'll review that, then look at their manual. And typically, if the attorney has cross referenced the operations manual 62 times, 61 of those mentions, there's nothing in the operation manual that expands on it. And that's just right for disaster. The franchisee is either going to do whatever they want to do, or they're constantly going to be calling the franchise company saying, look, I don't see this in the operations manual. How do I do x? How do I do y, et cetera? So it's very important in franchising that everything sings off the same song sheet. So our job is really to make sure. Yes, please, go on.

Mark Vandegrift
Well, you work with a few different franchise attorneys to draft the FDD. And we would say that most of these attorneys have expertise in very few industries, and they are experts in franchising. And do you find that really the only good results you get are from those that are specializing in franchising?

Steve Vandegrift
Sure, it's just like trademarking or patenting a product. Attorneys specialize quite a bit and franchising is no different than that. We actually get calls every year, inquiries from other franchise attorneys around the country. They say, look, we've heard some great things about FranSource. We're going to prepare their FDD, but we'd love you to assist them with all the other aspects. And when we explain that we actually walk our clients through the franchise disclosure document and all the terms and provisions. They're thrilled because probably 99 % will tell us that look, I can tell my client that the range for franchise fees is between X and Y, or the range in royalty fees are X and Y. And then they say it becomes a circle. The client will say, so what do you recommend? And the attorney will say, well, what do you want to do? And they'll say, well, what do you think we should do? Well, we're actually able to give those benchmarks. And so when we explain to a third party attorney that we actually work with questionnaires, we send them across so they know exactly what we're talking about, they're thrilled because they say, guys have reward experience. You can really help my client get to the finish line because of your expertise. And so that works out very well for the client. It works out great for the attorney. And certainly we're happy to help with that part of the equation. It's unfortunate to say that there are many, many franchise development firms out there that will refer you to a handful of attorneys. You pick your attorney, and then there's no additional communication between the consultant and the attorneys. Well, that makes it very difficult, A, for the consultant to provide that advice to the client as they're going through that process with the attorney. So consequently, once again, the franchise agreement can say one thing and ultimately the operations manual ends up saying something else. And everything in franchising really does need to sing off the same song sheet. Whether we're talking the legal, the operations, the marketing, the sales, we need everything to be consistent within all components of that franchise operation. Otherwise, you're going to confuse prospective franchisees.

Mark Vandegrift 
So when the FTD is finalized, that is submitted to whom?

Steve Vandegrift 
That's the interesting thing. In fact, even going through a development a couple months in, our clients will say, now, what's that process with registering with the FTC? There is no formal process. The FTC franchise rule relates to strictly preparing a franchise disclosure document in compliance with the rule. It's the attorney, their attorney's responsibility to make sure it fully complies. These registration states I mentioned, many of them will actually review the FDD. And trust me, if they find that it's not compliant, there's certain language that needs to be in there. Sometimes clients will say, boy, that cover page of the FDD, I'd rather this sentence say this. The problem is the FTC mandated it. So we know what's mandated. We know where we have some wiggle room in terms of the language. And that's so critical to really be able to develop a franchise disclosure document when properly drafted. Most people think of it simply as a legal document, but it's somewhat of a marketing piece as well because you can, in fact, share with franchisees or prospective franchisees various aspects of the operation that sometimes the attorneys don't think to include. And consequently, it just becomes that much more clear to the prospective franchisee as to what that franchisee franchisor relationship will look like.

Mark Vandegrift 
Well, we could certainly drill down into a lot when it comes to the FTD and we could probably make 23 podcasts just on each item in that. But I think what we'll do is finish up for today and we'll get into more detail on some later episodes. maybe give us a perspective here, just a real short one on why the FTD in and of itself is not something we feel is sufficient to offer prospective franchisees.

Steve Vandegrift 
Great question. And honestly, let's call it the internet age. Today, is when we when I co founded this company in 1997, you know, we were clients were advertising an entrepreneur, Wall Street Journal, etc. radio advertising, the internet changed all that. And so it makes it very easy for some to research a franchise opportunity. And if they're talking to a perspective, a franchisor is talking to a prospective franchisee and they're asking questions because they've gone through maybe a franchise presentation with a few other concepts and they're hearing about things like franchise operations and policy manuals, local marketing, social media marketing that the franchisor may conduct on their behalf. All of these other components are going to make that company that simply says, here's my franchise disclosure document, are you ready to go? They're going to say, well, where's the meat? Where's the meat on the bone, right? And they're gonna obviously choose another system that they feel has taken the matter seriously enough that they've really developed all of these various components. And that's why even as part of our development, we're introducing our clients to other third party providers that support franchisors. We want our clients to launch as if they have 25 or 50 franchises. And we've had many clients come back to us in that first month of starting to offer franchises. And they're pleasantly surprised to learn that their prospective franchisee is talking to three other companies. And one might have 35 franchises, but they don't offer the level of service and support that our clients offer, which were obviously initiated by us in terms of suggestions.

Mark Vandegrift 
Good. Well, let's wrap up today's episode of FranSimple. Thank you all for joining us. And as always, please like, share and subscribe to FranSimple, the podcast designed to make the concepts of franchising simple. Until next episode, may your business expand through the power of franchising.