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Tips From A Franchise Coach: The benefits and challenges of a uniform Item 19

Written by Rick Bisio, Forbes Council Member

Perhaps the most basic question people want to know when researching a franchise opportunity is, “How much money can I make?” It can be difficult to find a clear answer, but there are a few things you can do in order to gain a better understanding of one’s earning potential.

As a franchise coach, I’ve learned that the first step to determining your earning potential is to obtain a franchise disclosure document (or FDD). This is a report that provides extensive information about the franchisor and its relationship with the franchise owner. Item 19 of the FDD can include what is known as a financial performance representation (or FPR), which contains a specific level or range of sales, costs, income or profits that can be reasonably attained by a franchisee.

Although an FPR sounds like an extremely valuable resource, the problem is that the level of disclosure varies from one franchise to another. In my experience, few franchisors provide complete, top-to-bottom profit-and-loss statements in their FPR. Those that disclose complete FPR’s are often franchisors with multiple company-owned locations. That is because company-owned locations normally operate on the same chart of accounts and can be reliably and objectively consolidated.

Some franchisors do not disclose any financial performance information in their FDD, while other franchisors include a limited amount of data. This inconsistency can be frustrating to a franchise prospect researching an opportunity. From my perspective, this could also lead to a desire to someday have a uniform Item 19 policy for all FDDs.

What’s required of FDDs today?

To understand more about this topic, it is helpful to examine its history. Prior to FDDs, uniform franchise offering circulars (commonly referred to as UFOCs) contained “earnings claims,” which were similar to today’s Item 19. It is important to note that currently, the Federal Trade Commission allows the franchisor to disclose earning information in an Item 19, but does not require it. The franchisor has the option to disclose financial earnings information. If you go back 25 years to when I first started in franchising, very few franchisors provided any financial information in their disclosure documents.

There are several reasons for this. For example, a franchisor might not have complete and accurate financial performance at the franchisee level. Other times, the numbers are not very impressive, so the franchisor might not want to include them in the FDD. I’ve found that most often, a franchisor’s legal team feels the disclosure of financial information leaves them open for potential litigation and advises them not to include those details in the FDD.

Over the past 10 to 15 years, I’ve observed more franchisors have started to provide FPRs, which helps prospective franchisees learn more about the earning potential of a franchise system. We have moved in the direction of greater transparency, which I think is a positive step.

Right now, the most common type of disclosure is what I call a “partial disclosure.” This type of disclosure lists average gross sales figures and a few top-line costs, but it does not include earnings, profits or other bottom-line information. The reason for this is that unlike company-owned units, each franchisee adapts the chart of accounts to their own needs, which makes consolidation difficult.

Should there be a uniform Item 19?

For the above-mentioned reasons, requiring all franchisors to disclose comprehensive, top-to-bottom profits and losses in Item 19 would be very challenging and would require multiple subjective decisions. However, I do think there will come a point in which franchisors will be required to provide a partial profit-and-loss statement in Item 19 with average gross sales across their system. I believe implementing a uniform FPR would make sense and be helpful to the prospective franchisee.

Having a minimum standard disclosure would also be beneficial for franchisors, from my perspective. I’ve observed many franchisors are not sure what and how much information to include in Item 19, as they often rely on their attorneys. (If there are no standards regarding FPRs, then the methodology can potentially be questioned in the court of law.) By creating a standard requirement to provide basic gross sales average information across the system, I think it would be helpful for both the franchisee and franchisor.

Adding a uniform disclosure requirement to Item 19 wouldn’t directly answer the question of how much money someone will make with a franchise, but it can give a prospective franchisee a reliable starting point. Any kind of financial information taken from the FDD should be viewed as just the first step in understanding the earning potential with a franchise system.

As a franchise coach, I recommend that prospective franchisees speak with current franchisees in the system to learn if an opportunity is the right fit for them. This is a very important part of the due diligence process. Interviewing an owner allows the prospective franchisee to verify the information found within Item 19, discuss their experiences as a franchise owner and get a sense if they fit the culture of the franchise. It also gives the prospective franchisee the opportunity to ask specific financial questions and build out the entire summary of profits and losses. Current franchisees are one of the most valuable sources of information when it comes to creating an accurate and complete profit-and-loss statement.

If we eventually get to a point in which there is a required Item 19 disclosure, I believe a minimum requirement would be the best approach. Today, we have some franchisors that provide exceptionally comprehensive information in their FPR. I consider these franchisors as the standard-bearers when it comes to transparency. A provision allowing franchisors to exceed the minimum requirement would promote greater disclosure and benefit franchisors that are doing it right and providing the highest level of transparency.