Item 7: Estimated Initial Investment
Item 7 of the amended Rule requires franchisors to set out in a prescribed tabular format a franchisee’s entire estimated initial investment – i.e., all the expenses required by the franchise agreement and all other costs necessary for a franchisee to commence business. These expenses include items that are often paid to third parties, such as rent, equipment, and inventory. Accordingly, Item 7 gives prospective franchisees a much more detailed picture of their likely investment than Item 5 (initial fees) and Item 6 (other fees paid to the franchisor or affiliates).
Item 7 does not prescribe an exhaustive list of the types of fees or expenses that must be included in the table. The number and types of fees will necessarily vary depending upon the nature of the franchised business. However, Item 7 does list expenses that are typical, such as the initial franchise fee; training expenses; real property (whether purchased or leased); equipment; beginning inventory; and business licenses and related fees. In addition to these typical expenses, franchisors must itemize and identify any other specific required payments such as additional training, travel, and advertising expenses that franchisees will incur to begin operations.
Most of the expenses to be disclosed in Item 7 cover only the period prior to the date the franchise opens. Item 7, however, also requires franchisors to include in the table a category called “Additional funds – [initial period].” In this part of the chart, franchisors must list any other required expenses that franchisees will incur both before operations begin and during “the initial period” of operations.
The “initial period” of operations may vary from franchisor to franchisor. In general, a reasonable period is at least three months. Franchisors may use a longer period that is reasonable for the industry. Franchisors must disclose the specific initial period used, and describe the factors, basis, and experience they considered or relied upon to calculate their estimate of “additional funds.” Note that the “initial period” requirement covers only the “additional funds” item in the Item 7 chart.14 The other items in the chart pertain only to the period up to the date the franchised outlet opens for business.
For each item listed in the Item 7 chart, franchisors must disclose:
- the amount of the payment;
- the method of payment;
- when the payment is due; and
- to whom the payment is to be made.
If the amount of a payment is unknown, then franchisors may use a low-high range based upon the franchisor’s current experience. For real estate costs that cannot be estimated by a lowhigh range, franchisors may describe the approximate size of the property and building, and the probable location of the building (e.g., strip shopping center, mall, downtown, rural, or highway).
Item 7 requires franchisors to state, in footnotes, whether each payment is nonrefundable, or the circumstances when the payment is refundable. In addition, if the franchisor (or affiliate) finances part of the initial investment, the amount financed, the required down payment, the annual interest rate, rate factors, and the estimated loan repayments must be disclosed. The amended Rule permits franchisors to refer to Item 10 (financing) for additional details.
Item 7 reflects the typical initial investment made by a prospective franchisee buying a new or existing franchised outlet. On occasion, a franchisor may sell company-owned outlets to prospective franchisees. Ordinarily, the investment made in purchasing a company-owned store need not be reflected in the Item 7 estimated initial investment disclosure. However, if in the preceding fiscal year, the sales price of a company-owned outlet exceeded the highest initial investment for franchised outlets sales, then the franchisor should disclose that fact in a footnote in Item 7. Specifically, the footnote should indicate by how much the sale of company-owned outlets in the preceding fiscal year exceeded the highest initial investment for the sale of a franchised outlet.
CREDIT: The content of this post has been copied or adopted from the Federal Trade Commission’s Franchise Rule Compliance Guide.