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
that elaborate 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
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.