Documentation

If we go through the Compliance Guide of Franchise Rule formulated by the Federal Trade Commission of USA, we will find details about the Disclosure Document and all the 23 items which need to be disclosed to the Franchise buyer. 

Under the Franchise Rule enforced by the FTC, the buyer must receive the document at least 14 days before the buyer is asked to sign any contract or pay any money to the franchisor. The buyer has the right to ask for a copy of the Franchise Disclosure Document. 

Some of the important items out of those 23 items of the Disclosure Document are as follows: 

ITEM 1: Franchises Background

Item 1 tells us about the entire history of the Franchise Business, i.e., How long the franchise has been in the market, who all are the competitors to the franchise. For example: If a person wants to buy a McDonald’s Franchise, item 1 will contain the date on which it was founded [i.e., 1955 (66 years)], its competitors (Burger King, Dominos, etc). 

ITEM 2: BUSINESS EXPERIENCE

Item 2 contains business experiences of certain important individuals, which may include Directors, MD, Principal officer, etc. Such experience gives an idea about who is running the business and is the person is capable enough to run it or not. 

ITEM 3: LITIGATION HISTORY

Item 3 discloses all the lawsuits to which the franchisor or any of its executive officers are parties. 

ITEM 4: BANKRUPTCY

Item 4 discloses whether the franchise, its affiliate, or any of its executives have been subjected to Bankruptcy. If yes, the buyer must carefully look at the Financial Statements of the Company of the last few years and check whether the business is in stable condition or not.  

ITEM 5 & 7: INITIAL AND OTHER COSTS: 

This item discloses some pre-commencement franchise costs. Generally there is no Initial cost to the buyer before starting a business but if some franchise wishes to charge cost, they must disclose it in item no 5. It also explains other fees like royalties and advertising fees., training fee etc. The franchise shall also disclose the estimated initial franchise investment to the buyer. 

ITEM 8,12 & 16: SUPPLIER, TERRITORY & CUSTOMER RESTRICTION: 

This item contains all the restrictions imposed on the franchisor. The limits include suppliers from whom one may purchase goods or the goods or services one may offer for sale etc. Such restrictions may limit your ability to carry out the Franchise Business. 

ITEM 11: ADVERTISEMENT AND TRAINING

Franchisees are often required to contribute a percentage of their sales to ads and the training of their employees to run a business. Such costs have to be disclosed under this head. 

ITEM 13 & 14: TRADEMARKS AND PATENTS

The franchise must disclose all kinds of Intellectual Properties they owe. 

ITEM 17: RENEWAL, TERMINATION AND DISPUTE RESOLUTION 

The item will tell you about the terms of renewal, conditions for termination, and if there is a dispute between the Franchise owner and franchisor, how the dispute can be resolved. 

ITEM 19: FINANCIAL PERFORMANCE

You can track the financial performance of the company under this item head. It is really important for any potential buyer to go through this item in order to make future decisions about investing in the Franchise Business. Poor Financial performance should be a big cross, and buyers shall not invest in such companies.  

ITEM 20: OUTLETS AND FRANCHISE INFORMATION

Item 20 requires the disclosure of statistical information on the number of franchised outlets and company-owned outlets for the preceding three-year period. If the charts show more than a few franchised outlets in your area have closed, transferred to new owners, or transferred to the franchisor, it could be due to problems with the franchisor’s support or because franchises aren’t profitable.

UFOC Template

The Template of UFOC can be found on: https://franchiseprep.com/docs/fdd/Sample%20Franchise%20Disclosure%20Document%20FDD.pdf 

A term sheet is a non-binding agreement outlining the essential investing requirements. It can be a starting point for creating more extensive, legally binding papers. An agreement or contract that complies with the term sheet's provisions will be drawn out once the parties concerned have reached an agreement on the details set out in the term sheet. In general, a term sheet should describe the most significant components of a contract without getting into small details or contingencies that would be handled by a formal contract.

It simply lays the framework for ensuring that the parties engaged in a business transaction agree on the most critical parts, reducing the risk of misunderstanding and unnecessary litigation. It also guarantees that significant legal fees for drafting a formal agreement or contract are not incurred prematurely.

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Typical Clauses Included In a Term Sheet

1. Is the Term Sheet Legally Binding?: No, save in the case of legal liability for confidentiality, exclusivity, and costs. The goal is to specify the terms and see if the agreement has enough legs to close between the parties.
2. Assessing the Worth of Your Company: Calculate the value of your firm realistically using comparable companies as a baseline. A high value may look good on paper, but it will also raise the bar for future fundraising if you want to acquire another round.
3. Due Diligence: It's critical for the founder to conduct full due diligence on everybody they'll be doing business with. One of the major concerns raised by venture capital and private equity firms is that the entrepreneur does not conduct their due diligence on their long-term partner. Be specific about how your investors will assist your company in ways other than finance.
4. Financial Instrument: Stocks, which include preferred and ordinary stocks, are the most popular equity. Convertible debt notes are becoming more popular.
5. Partner Participation Rights: There are three categories of partner participation rights, each with a different level of economic upside potential for investors.
   • Non-Participating — The choice that is most owner-friendly. The investor must select between a straight preference for liquidation or a pro-rata share of all proceeds.
   • Capped Participation – Similar to the Full (see below), but the total return from liquidation and participation rights is limited to a certain multiple.
   • Full Participation - This is the most investor-friendly option. The investor gets their liquidation preference first, followed by a pro-rata share of any residual funds. Determine the voting rights of each of the three different sorts of investors.
   • Determine the voting rights of each of the three different sorts of investors.
6. Pro-rata Rights: Pro-rata rights give initial investors the choice (but not the obligation) to invest in subsequent rounds to keep their ownership, which would otherwise be eroded.
7. Liquidation Preference: Liquidation preferences define the payout hierarchy in the case of a corporate liquidation, such as a sale or merger. Liquidation preferences allow investors to specify the initial payout amount and breadth that they will receive.
8. Anti-dilution Provisions: This right protects an investor from equity dilution caused by future stock issues if the stock is sold for less than the original investment price. This also changes relative ownership percentages to prevent new stock investors' stakes from being lowered.
9. Protective Provisions: Protective Provisions give investors veto power that they would otherwise be unable to wield on the board of directors since their percentage share does not equal a majority vote. Examples are forcible discussions, such as a company sale, stock issuing to costs, or hiring sign-offs.
10. Drag Along Rights: This provision permits investors to persuade other stock classes to comply to their voting requests in the event of a liquidation event such as a sale, merger, or dissolution.
11. Right of First Refusal/Right of Co-Sale: Notifies all investors about stocks available for acquisition by other investors and requires board approval of all stock transfers to prevent stock transfers that are done in secret.
12. Guarantees: If the founder is needed to be a guarantee, specify how and when the guarantor will be removed from the note.
13. Vesting Schedule: Vesting is the method through which a company's shares/equity are earned over time (typically four years or fewer.) When a founder with vested stock leaves unexpectedly, the cap table is left with dead-equity. This event may have significant ramifications for the remaining founders and funders.
14. Liquidation Preference: Liquidation preferences allow investors to specify the initial payout amount they will receive.
15. Confidentiality and non-competition protect investors from conflicts of interest that develop when they try to leverage their portfolio by sharing information or investing in competitor enterprises. The duration of this insurance spans from two to twenty years (as seen in oil and gas deals.) In addition, the founder wants the investor to be entirely focused on guaranteeing the success of their company.
16. Mediation/Arbitration/Governing Law and Jurisdiction: Disputes arise that necessitate the intervention of a third party. If this action is required, ensure it is handled in the most convenient jurisdiction for you.

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How Can VCs Protect Their Interests In A Term Sheet?

Four provisions must be included in the term sheet to protect the interests of VCs:

1. Voting Rights: Preferred stock frequently includes Board seats and voting rights. Venture investors have a greater say in the company's operations, management, and direction due to this.
2. Dividends: Dividends are features that distinguish preferred stock from common stock. Dividends boost the overall return for preferred investors while lowering the total return for common stockholders. Dividends are sometimes expressed as a percentage of the preferred stock's initial issuance price.
3. Participation and Liquidation Preferences: Participation and liquidity preferences ensure that the investment is compensated before a liquidity event occurs (when a company is sold, goes public or declares bankruptcy). These considerations are critical if the company is liquidated for less than the amount invested.
4. Anti-Dilution: In the event of a down round, a firm issues equity at a lower valuation than in earlier rounds, the anti-dilution provision protects investors.

The majority of term sheet protections are paid for by common shareholders, who include founders and workers, so it's critical that they're reasonable and equitable. If a VC is overly shielded, it can stifle a company's growth and success by reducing its ability to attract talent and attract new investors in the future.