FDD Item 8: Restrictions on Sources of Products and Services Explained
Item 8 of the franchise disclosure document requires franchisors to disclose any restrictions on where franchisees can purchase or lease goods and services needed to establish and operate the franchise. It also requires disclosure of revenue or other material benefits the franchisor, its affiliates, or officers may receive from required purchases or leases. It is governed by 16 CFR 436.5(h).
What Is Item 8 of the FDD?
Item 8 covers purchase obligations imposed on franchisees by written agreement or by the franchisor’s practice. It applies to goods, services, supplies, fixtures, equipment, inventory, computer hardware and software, real estate, and comparable items. The disclosure requirements are codified under 16 CFR 436.5(h) and enforced by the Federal Trade Commission.
Many franchisors restrict where franchisees can source products and services to maintain brand standards across the franchise system. Item 8 gives prospective franchisees a clear picture of those restrictions before signing a franchise agreement.
What Must Be Disclosed in Item 8?
Required Purchases and Approved Suppliers
Franchisors must disclose what goods or services franchisees are required to purchase from the franchisor, its affiliates, or approved suppliers. Item 8 must also disclose whether the franchisor or its affiliates are approved or the only approved suppliers for any required category. When the franchisor or an affiliate is the sole source, prospective franchisees have no purchasing alternatives for that category.
Franchisor and Officer Ownership Interests in Suppliers
Franchisors must disclose whether the franchisor or any of its officers owns an interest in a supplier from which franchisees are required to make purchases. Because ownership interest requirements can be complex, franchisors should work with experienced franchise attorneys to evaluate what requires disclosure.
Revenue Derived From Required Purchases
Franchisors must disclose the total revenue derived by the franchisor and its affiliates from required franchisee purchases. Item 8 must explain the basis for any rebates, commissions, markups, or other supplier payments and disclose the percentage of the franchisor's total revenues represented by those required purchases. The estimated proportion of required purchases or leases made from restricted sources compared to all required purchases and leases must also be disclosed.
Material Benefits Tied to Supplier or Product Use
Item 8 must disclose whether the franchisor provides material benefits to franchisees based on use of certain products, services, or suppliers. Material benefits can include renewal rights or the right to acquire additional franchise locations. When such benefits exist they must be disclosed so prospective franchisees understand how purchasing decisions may affect their standing in the franchise system.
Specifications, Standards, and Purchasing Cooperatives
Franchisors must disclose under 16 CFR 436.5(h)(5) whether they issue specifications and standards to franchisees or approved suppliers. Rather than naming a specific vendor, specifications define the standards a product or service must meet and give franchisees more flexibility to source from multiple vendors.
Item 8 must also disclose whether the franchisor negotiates purchase arrangements with suppliers for the benefit of franchisees and whether purchasing or distribution cooperatives exist. If cooperatives exist, Item 8 must disclose whether participation is required and who manages them.
The Approved Supplier Process
Item 8 must disclose whether franchisees may use alternative suppliers and if so how that process works. Required disclosures include:
- Whether alternative suppliers are permitted
- How a franchisee requests approval for a new supplier
- Whether approval criteria are available to franchisees
- How long the approval process typically takes
- Whether supplier approval may be revoked and under what circumstances
Common Mistakes Franchisors Make With Item 8
Officer ownership interests in required suppliers must be disclosed. Revenue or other material consideration received by the franchisor or its affiliates from required purchases must also be disclosed. Both create compliance gaps under the Franchise Rule when left out. Rebates, commissions, markups, and the percentage of the franchisor’s total revenues those payments represent must all be addressed accurately in Item 8.
Franchisors also commonly omit material benefits tied to purchasing compliance such as renewal rights or additional franchise opportunities. These must be disclosed when they exist.
Franchise Genesis
How Franchise Genesis Helps Franchisors Prepare Item 8
Item 8 involves some of the more nuanced disclosure requirements in the FDD. Supplier relationships, officer interests, revenue from required purchases, cooperative arrangements, and material benefits all require careful review before disclosure.
Franchise Genesis works with franchisors to prepare a franchise disclosure document that is accurate, compliant, and built to support franchise sales. Experienced franchise attorneys are included in the development program. They evaluate supplier relationships, assess ownership interests, and structure Item 8 disclosures correctly under 16 CFR 436.5(h).
Frequently Asked Questions
Item 8 discloses restrictions on where franchisees must purchase or lease goods and services to establish and operate the franchise. It also requires disclosure of revenue or other material benefits the franchisor, its affiliates, or officers may receive from required purchases or leases. It is governed by 16 CFR 436.5(h).
Franchisors can require franchisees to purchase from approved suppliers or under franchisor specifications. Item 8 must disclose whether the franchisor or an affiliate is the only approved source for any required category.
Officer ownership interests in required suppliers must be disclosed. Revenue or other material consideration received by the franchisor or its affiliates from required purchases must also be disclosed, including rebates, commissions, markups, and the percentage of total franchisor revenues those payments represent.
Franchisees may use alternative suppliers only if the franchise agreement and franchisor approval process allow it. Item 8 must disclose whether alternative suppliers are permitted, the criteria for approval, how long approval typically takes, and whether approval can be revoked.
Source restrictions can limit a franchisee’s ability to compare vendors or find lower pricing. The proportion of required purchases or leases made from restricted sources compared to all required purchases and leases must be disclosed in Item 8. A high proportion of restricted purchases can affect profit margins and should be reviewed carefully before signing a franchise agreement.