Item 19: Financial Performance Representations
Content: This is “information given to a prospective franchisee by, on behalf of or at the direction of the franchisor or its agent, from which a specific level or range of actual or potential sales, costs, income or profit from franchised or non-franchised units may be easily ascertained.”
Purpose: In short, the declaration of a Financial Performance Representation gives the prospect an expectation of how much money can be made from the business. On the other hand, if no representation is made, information must be collected through interviewing the existing franchisees.
Tips & Advice: In early franchise history, this is the area that triggered a lot of the involvement of the FTC. Less than reputable franchisors made unfounded claims about the income people could earn through their franchises. Obviously, anyone looking at a business wants to know how they make money, but misleading people is unacceptable. That is why Item 19 is important. Any representation a franchisor makes must be in writing and must be in the Franchise Disclosure Document. Today, the majority of franchisors do not make financial performance representations for a couple of reasons. For one thing, the franchisor may not have complete, accurate profit and loss information on the franchisee level. It can be time consuming and expensive to collect that data. Perhaps the stronger motivation for not making a representation is the history of litigation associated with these types of statements. Today, only about 25% of franchisors provide some type of limited performance representation.
If the franchisor chooses to make a Financial Performance Representation in Item 19, then the franchisor can discuss earnings with you up to the extent of the claim. In other words, if the franchisor provides Gross Sales averages, they can discuss Gross Sales averages – but not Net Profitability. If the franchisor does not make an Earnings Claim, they are legally prohibited from discussing earnings with you.
Whether the franchisor makes an earnings claim or not, the existing franchisees themselves are the best source of information. In Chapter 12, we will deal with the critical issue of how to develop a model profit and loss statement.