When looking into buying a franchise, you may find it challenging to figure out your earning potential as a franchisee. Franchisors aren’t being cagey or difficult if they seem reluctant to give you that information. Rather, they’re being mindful of the stringent regulations put in place by the Federal Trade Commission (FTC) and many states. These regulations govern the way franchisors provide earnings claims and related financial information to prospective franchisees.
Why the government regulates franchisors
In the early days of franchising, it was not uncommon for franchisors to make misleading or unsubstantiated claims about earnings. In 1979, Congress sought to put a stop to deceptive practices by authorizing the FTC to regulate the franchise industry. A number of individual states passed similar legislation as well. Current law does enable franchisors to provide earnings information if they so choose. But they must adhere to specific regulations governing the way this information can be given to prospective franchisees.
Importantly, the franchisor must put earnings claims of any kind in writing in Item 19 of their Franchise Disclosure Document (FDD). The information can be historic data or a forecast of future performance, but either way it must be clearly labeled as such. The franchisor may not set forth any unsubstantiated, inaccurate, or misleading data. And any assumptions or qualifications must be clearly labeled as such.
Why don’t all franchisors provide this information?
It sounds relatively simple to do, but many franchisors refrain from setting forth earnings claims in their FDD. This is usually due to one of two reasons. First, producing accurate earnings claims involves significant effort and expense on the part of the franchisor. Second, the figures may not be high enough to attract new franchisees.
Looking beyond the FDD
If a franchise doesn’t provide earnings claims in their FDD, don’t despair. Another reliable of earnings information lies in your hands: the FDD’s list of franchisees. Speaking with franchisees will be a vital part of your due diligence as you investigate franchise opportunities. While you have them on the phone, be sure to ask about average earnings and the range of earnings of units in the franchise system. Gathering actual performance statistics will help you determine how much you could expect to make as a franchisee.
How do the earnings claims measure up?
Once you’ve obtained earnings data, you need to decide whether it meets your threshold for a worthwhile return on investment (ROI). Remember, you are investing your time and talent as well as your money. Therefore, you should look to make a greater return than you would expect for a passive “money-only” investment. For example, if you consider 10-15% to be a healthy annual return on a passive investment, look for a higher return when you evaluate franchise opportunities.
Although it may seem counterintuitive, keep in mind that a higher level of investment does not necessarily bring about a higher rate of return. There are plenty of low- to mid-range investment franchises that offer a worthwhile ROI. Don’t limit yourself to only high-investment franchises when seeking a high ROI.
The amount of money you can make as a franchisee depends on many factors. It may vary according to the structure of the franchise (e.g. retail versus service), the amount of time your franchise has been operational, the degree to which you understand and embrace the system, and your enthusiasm for the business. But with a little research, you can gather enough data to give you a good idea whether an opportunity makes financial sense for you.