Item 14 of the franchisor’s disclosure document is crucial as it details the costs that franchisees can expect before starting and while running their business. It covers start-up and operational expenses, as well as capital costs such as equipment and property improvements. Clear and accurate information here is vital for potential franchisees to grasp their financial obligations, fostering trust between franchisors and franchisees.
Information to Include in Item 14
Item 14 must outline all foreseeable costs before and during the franchise operation, including:
- Franchise Fees: Payments to the franchisor.
- Training Costs: Expenses for initial training.
- Equipment and Supplies: Costs for necessary items.
- Real Estate and Build-Out Costs: Expenses for property and improvements.
- Licenses and Permits: Legal operation fees.
- Interest and Finance Costs: Financing expenses.
- Miscellaneous Expenses: Other necessary costs.
- Ongoing Operational Costs: Regular business expenses.
- Capital Expenses: Detailed timing, nature, and justification.
Each cost should be clearly defined to help franchisees make informed decisions. In most cases, the disclosure document must be updated annually, within 4 months of the end of each financial year. The information provided in the disclosure document, including item 14, must be correct at the date of the document. Given this, for most franchisors, revising Item 14 will be an annual exercise.
Girchow v UFG: The Importance of Accuracy
The Federal Court case Girchow Enterprises Pty Ltd v Ultimate Franchising Group Pty Ltd (Final Hearing) [2023] FCA 420 underscores the consequences of inaccurate Item 14 disclosures. UFG provided misleadingly low cost estimates in Item 14, ultimately leading to financial harm for franchisees. The court held UFG accountable for misleading and deceptive conduct, and that the individual directors had been involved in the breach of the statutory provisions, also rendering them personally liable. The end result of this litigation is the franchisor went into liquidation, one individual is bankrupt, and the other is appealing the decision, demonstrating the potentially disastrous impacts of having inaccurate information contained in item 14. This case highlights the critical need for precise and updated disclosures to avoid legal and financial repercussions.
Tips for Ensuring Accuracy in Item 14
To maintain accuracy in Item 14:
- Regular Reconciliation: Compare estimated costs with actual expenses and bookkeeping data of actual franchisees and any corporate sites, to ensure all costs are covered, and the figures are accurate.
- Monitor Legislative Changes: Update costs to reflect new regulations, for example, increased wage costs arising from updated modern award rates. Ensure any such increased costs are incorporated into item 14.
- Supplier Communication: Stay informed about price changes. Research any price increases in COGS. Doing so can also be a great opportunity to test the market for more competitive suppliers.
- Range of Costs: Provide a realistic cost range when exact figures are uncertain. Consider geographic, freight, and other variables in determining the appropriate range.
- Frequent Updates: Regularly revise the disclosure document, and keep track throughout the year of any necessary additions or updates.
- Financial Tools Caution: Ensure any provided financial models reflect accurate costs, and the underlying data matches what is in the disclosure document. Any such tool should be accompanied by a disclaimer, and itemisation of any underlying assumptions for clarity.
- Consider Economic Changes: Account for inflation and cost of living increases.
- Legal Compliance: Understand and adhere to misleading and deceptive conduct laws. Here, franchisor’s need to ensure there is a reasonable basis for including all the items and figures they do in Item 14.
- Include Disclaimers: Inform franchisees to conduct their own due diligence, and include robust disclaimers in Item 14 itself.
- Legal Consultation: Seek legal advice to ensure compliance and completeness. An experienced franchise lawyer will be able to compare Item 14 with comparable brands and identify any obvious omissions.
- Capital Expenditure: Comply with the Code requirements concerning capital expenditure, per our article here.
Conclusion
Accurate and current information in Item 14 of the franchisor’s disclosure document is crucial for prospective franchisees. It outlines financial commitments and helps build trust. The Girchow v UFG case highlights the risks of inaccurate disclosures, emphasizing the importance of thoroughness and transparency. By following best practices and legal guidelines, franchisors can protect themselves and foster successful franchise relationships.