In my over 30 years of franchise consulting experience, I am often asked if a Franchisor can give financial projections or earnings claims that potential franchisees will use to help them determine if they should purchase a particular franchise opportunity.
In the last blog post, we discussed the rules and regulations regarding the preparation of Financial Performance Representations (FPR) in Item 19 of the Franchise Disclosure Document (FDD). Let’s take another look at the definition of a FPR.
The FTC definition of a FPR covers any representation, including oral, written or visual information, given to a franchise sales prospect — including a representation in the general media — that states, expressly or by implication, a specific level or range of actual or potential sales, income, gross profits or net profits. FPRs include charts, tables or mathematical calculations that show possible results.
The first question posed by most franchise sales prospects is “How much money can I make if I buy your franchise?” An issue that all new Franchisors must address is whether their new franchise company should offer FPRs in the FDD to answer this question. Remember, all franchise sales prospects must receive a FDD no later than the first face-to-face meeting with the Franchisor.
If the Franchisor wants to disclose FPRs in the FDD, the company must have a reasonable basis for such financial representations. The Franchisor must also have written substantiation for the FPRs and make this verification available to any franchise sales prospect who requests it.
While most Franchisors do not prepare FPRs for their FDDs, there are reasons to consider doing so, including:
- It is often difficult to sell the first franchise without giving franchise sales prospects an understanding of their chances of making a reasonable return on their initial investment. Item 7 of the FDD lists the expenses the franchise sales prospect will encounter in opening the franchise.
- A FPR can result in a better-informed Franchisee.
- Banks, financial institutions or individuals may be more inclined to provide financing for the franchise sales prospect.
- If the only option for franchise sales prospects is to contact existing franchisees for financial information, they may get a poor sampling.
- Disclaimers in the FDD’s Item 19 may protect the Franchisor from liability if there is litigation over this issue.
- A properly-prepared FPR can limit problems if a franchise sales person inflates the financial return on investment and yearly profits.
- Disclosing financial information (Balance Sheets, Income Statements, etc.) for a particular Franchisor-owned unit is allowed if the location is being sold by the Franchisor.
Giving out FPRs can make it easier to sell franchises, particularly at the outset of a franchise program. However, there are significant potential liabilities associated with disclosing FPRs, and I will discuss this topic in our next Blog.
The vast majority of Franchisors do not give financial performance representations (FPR) because of the potential liability they may face if the franchisee does not achieve the numbers disclosed in the FPR.