The Franchise Business Opportunity Project Group of the North American Securities Administrators Association (NASAA) recently released a proposed commentary on multi unit franchise arrangements. In the commentary, the group which is made up of state regulators and advised by experienced franchise attorneys recommended several changes to the way franchisors disclose multi-unit franchising arrangements to prospective investors.

Their recommendations included standardizing the definitions of area development, sub-franchise and area representation and prohibiting combined FDDs for both unit franchises or area development franchises (combining those two would be permitted) and either subfranchises or area representation arrangements.The changes will benefit both prospective investors and franchisors by creating a uniform approach to terms and providing better and more accurate information to investors.

In the commentary, NASAA proposed the use of standard terms which are defined by what rights the franchisor is granting. Thus any franchise relationship in which the franchisor grants a party the right to operate multiple franchises within a defined area is an “Area Development” arrangement. A franchise relationship in which the franchisors grants a party the right to grant third parties the right to operate franchises is a “Sub-Franchise” arrangement. And finally any relationship in which the franchisor grants a party the right to recruit, sell to, or provide significant support services to third party franchisees is an “Area Representation” arrangement.

If a franchisor is fanatically devoted to using a different label, under the new commentary, it could still do so. The commentary simply asks that if a franchisor wants to use terms different from the ones defined above they must identify those terms and explain how they relate to the recommended terms in a cover letter to state regulators.

In a recent article, one franchise attorney criticized the requirement that franchisors use a separate FDD for area representatives or sub-franchisors from the FDD they provide to prospective unit franchisees and area developers. The critic expressed two major concerns 1) it would be more expensive for the franchisors to create and file up to three FDDs (franchisee, area representative, and sub-franchise); and 2) that some franchisors that had been considering offering area representative or sub-franchisor arrangements may chose not to do so. However, as the commentary explains, large portions of the FDDs overlap and franchisors would not have to create entirely new FDDs. Rather they would have to modify their existing FDDs to more accurately describe the specific nature of the multi-unit arrangement. Expenses would increase but they are unlikely to “double.” As to the second point, a franchisor that is unable to pay the relatively minor additional expenses required to begin offering multi-unit franchises is likely to have a much larger problem meeting the needs of its existing franchises and probably should be rethinking its priorities. In addition, better informed franchisees may result in less claims and litigation, thus reducing risk and expense for all parties.

I will address specific elements of the commentary in later posts but the single greatest benefit of the new rule is that it simplifies and standardizes the words franchisors use when they described the type of franchise being offered. Better information in the FDD provided to a prospect will likely result in better informed and more successful prospects whether they are a franchisee, area developer, sub-franchisor or area representative.
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