Try before you buy doesn’t apply to franchises.
Signing as a new franchisee pairs you with an established business. Make sure it’s a mutually beneficial partnership.
You can accomplish this through patience and a thorough review of the system’s financial data.
By the time we wrap up, you’ll understand the most important section of this disclosure document. And have actionable insights to guide a final decision.
Read on if you’re ready to begin a fulfilling entrepreneurial journey.
What is Item 19?
Joining a franchise system becomes less risky when you know its potential financial performance.
And your best way to determine this is item 19.
You’ll find it in your Franchise Disclosure Document (FDD). Known as the “Financial Performance Representation (FPR)” or “Earnings Claim,” item 19 contains past financial performance of a franchised business.
Such representations aren’t mandatory. But their absence should even cause existing franchisees to ask questions. After all, it’s fair to expect a reasonable basis for your decision to buy or not to buy.
However, franchisors who choose not to share them must still have a prescribed statement in the FDD.
Setting that aside for a moment, let’s look at what to expect from a thriving franchise system.
Actual records include:
- Gross sales
- Gross profits
- Other financial performance data
These admissions provide franchisee candidates with industry-specific numbers.
It’s almost a visual representation of the franchisor’s management. Or lack thereof.
The FPR will include one of two types:
Actual financial results are contained within the traditional variety. In the second, you can view the predicted earnings.
Forecasted performance is more common with newer franchisors. Because obviously, they don’t have an established track record.
Next, we’ll talk about how FPRs are regulated.
Role of State Regulatory Agencies
Appropriate state regulatory agencies oversee disclosure requirements. Primarily the Federal Trade Commission (FTC).
They ensure that franchisors provide a representative sample to potential franchisees. Without these guardrails, abuse would surely transpire.
Traditional FPRs must include:
- How many outlets were measured
- The time period that was looked at
- Percentage of outlets that reached performance level
- And more
Additional detailed information supports the data. Plus, it establishes trust between both parties.
Early on, this strengthening can prevent later breakdowns in the business relationship.
It’s hard to put a price on setting a firm foundation of honesty for a possible partnership. It’s so hard in fact, that we’ll simply call it priceless!
The FTC Rule has a broad definition for our topic, but one fact isn’t open to discussion.
Should a franchisor verbally share financial performance information, written substantiation must be provided under item 19. Whether it’s during the offer or actual sale.
Non-traditional FPRs might include:
- Studies of the existing market
- Analysis using a mathematical calculation
We notate “might include” because the information they share in non-traditional types may vary significantly.
Moving on, let’s address why financial information should be given to you ahead of time.
Prospective Franchisees Deserve Financial Data for Potential Sales
Franchise sellers without actual operating results owe you a measure of transparency. Why?
As a prospective franchisee, you’re trying to make a financial performance determination. Without all the facts, you’re severely limited in your ability to do so.
It’s partially up to them on what data will effectively relay the potential of success.
But there are general factors you should consider:
- Economic or market conditions
- Cost of goods or services sold
- Operating expenses
Likelihood of sales
A particular franchise system’s financial performance will affect all franchisees. That’s a given.
But what isn’t as clear is how likely you are to enjoy rich rewards. Similar to a traditional FPR, your franchisor must still include a certain statement. Which relays that “individual results may vary.”
Actual or potential sales will depend on your ability to launch and run a profitable venture. But before you sign the franchise agreement, be discerning in your dealings with the seller.
This becomes much easier when you’re working with a franchise lawyer. Their familiarity with necessary disclosures is well worth any investment.
Now, it’s time to talk about your favorite subject. Future income!
Benefit of Financial Performance Representation
When potential purchasers like yourself are in front of a franchisor, it might appear like an interview.
Just remember that you’re on equal standing. And should ask your own questions.
It’s all part of your due diligence.
Because any franchisee’s future financial performance is based on material assumptions at this stage. Change that.
- The number one benefit of entrepreneurship is an earning potential unreachable as an employee
Even high-paid salaried employees have a cap set by the organization. A sound franchise opportunity is different.
Technically, your ability to earn is unlimited.
And the knowledge you glean while running a business translates to various industries. Should you later decide to shift from washing cars to supplying those same vehicles with gasoline for example.
Address the following areas to ensure a purchase makes sense for a new franchisee like yourself:
- Estimated profit margin
- Normal break-even point
- Gross revenue
If the franchisor points you in the direction of another franchisee for answers, consider it valuable. It’ll likely generate a more realistic picture of the overall system.
Another benefit of this connection could be a future mentor. Learning from an existing outlet might help you avoid mishaps they had to deal with.
To conclude, let’s address the number one way to make a sound decision on a possible franchise.
Reidel Law Firm and Franchise Disclosure Document Review
As experts in franchise law, we can help you review FDDs. Increasing the possibility that you will continue to provide for yourself and your family. Well into the future.
In addition, our legal team can advise you on ways to shore up gaps in the following areas:
- Review personal guaranty and real estate control docs
- Franchisee formation, guidance, and asset protection
- Franchise operating compliance audit and coaching
We’ve worked with both franchisors and franchisees. Giving us a well-rounded knowledge of what should be included in item 19.
By effectively managing risk and maximizing opportunities for businesses we answer the needs of our clients wherever and whenever they arise.
Call Reidel Law Firm today at (832) 510-3292 or fill out our contact form. And see how our advice can bring you success in the franchise business.