Item 11 – Required Disclosures
By Mario Herman
Prospective franchisees should understand their obligations to advertise their franchise products and services. In addition, recognizing how the franchisor administers the advertising fund is equally important.
Under Item 11 in the Franchise Disclosure Document (FDD), a franchisor is required to disclose to each prospective franchisee important facts regarding its advertising programs. A franchisor must describe the advertising program for the franchise system, including:
(i) The franchisor’s obligation to conduct advertising, including:
(A) The media the franchisor may use.
(B) Whether media coverage is local, regional, or national.
(C) The source of the advertising (for example, an in-house advertising department or a national or regional advertising agency).
(D) Whether the franchisor must spend any amount on advertising in the area or territory where the franchisee is located.
(ii) The circumstances when the franchisor will permit franchisees to use their own advertising material.
(iii) Whether there is an advertising council composed of franchisees that advise the franchisor on advertising policies. And, if so, the franchisor must disclose: a) how members of the council are selected; b) whether the council serves in an advisory capacity only or has operational or decision-making power; and, c) whether the franchisor has the power to form, change, or dissolve the advertising council.
(iv) Whether the franchisee must participate in a local or regional advertising cooperative. And, if so, the franchisor must state: a) how the area or membership of the cooperative is defined; b) how much the franchisee must contribute to the fund and whether other franchisees must contribute a different amount or at a different rate; c) whether the franchisor-owned outlets must contribute to the fund and, if so, whether those contributions are on the same basis as those for franchisees; d) who is responsible for administering the cooperative (for example, franchisor, franchisees, or advertising agency; whether cooperatives must operate from written governing documents and whether the documents are available for the franchisee to review; f) whether cooperatives must prepare annual or periodic financial statements and whether the statements are available for review by the franchisee; and, g) whether the franchisor has the power to require cooperatives to be formed, changed, dissolved, or merged.
(v) Whether the franchisee must participate in any other advertising fund. And if so, the franchisor must state: a) who contributes to the fund.; b) how much the franchisee must contribute to the fund and whether other franchisees must contribute a different amount or at a different rate; c) whether the franchisor-owned outlets must contribute to the fund and, if so, whether it is on the same basis as franchisees; d) who administers the fund; e) whether the fund is audited and when it is audited; f) whether financial statements of the fund are available for review by the franchisee; g) how the funds were used in the most recently concluded fiscal year, including the percentages spent on production, media placement, administrative expenses, and a description of any other use.
(vi) If not all advertising funds are spent in the fiscal year in which they accrue, how the franchisor uses the remaining amount, including whether franchisees receive a periodic accounting of how advertising fees are spent.
(vi) The percentage of advertising funds, if any, that the franchisor uses principally to solicit new franchise sales.
Advertising issues, including the prospective franchisees expectations regarding the use of the funds contributed and how the funds will be maintained (i.e., kept separate from operational funds) are important issues to iron out before you sign the franchise agreement. Advertising fees are most often charged in addition to any royalties and other fees charged, and can run 3% or higher of your gross sales. This is a considerable amount of funds, and you should make sure that you feel assured, in writing, by the prospective franchisor that you will be receiving the advertising serves that you are expecting. You should also examine the franchise agreement carefully to see what restrictions and/or expectations/requirements are placed on you regarding your conducting your own advertising program. An experienced franchise law attorney can help you examine the contract language, and make sure your interests are as protected as much as possible.
Mr. Herman, licensed in Washington, D.C., represents franchisees
domestically and internationally in negotiation, mediation, arbitration, and
litigation with their franchisors.