When researching franchise opportunities, you’ll spend a significant amount of time reviewing franchise financial information. And it’s common to wonder: can I trust the information that franchisors provide?
Fortunately in this case, the Federal Trade Commission strictly regulates franchise sales. Statutes and regulations govern the franchise sales process, as well as the documents and disclosures that franchisors give prospective franchisees. So the answer is yes, you should be able to trust the franchisor’s financial disclosures. Otherwise, the franchisor is violating federal law. That said, it’s important to know that the disclosures only represent past performance of units that are/were open. They’re not a predictor of future costs, revenues, or profits. For this reason, it’s especially important to do careful due diligence.
The FTC Franchise Rule
In 1979, the Federal Trade Commission introduced a “franchise rule.” This was its first step to regulate the sale of franchises. While these FTC regulations have changed over time, the basic tenets remain consistent.
Critical sections of the FTC’s franchise regulations govern the content and format of the Franchise Disclosure Document (FDD). The FDD is a legal document that a franchisor must give to individuals interested in buying a franchise. It is a critical source of information, and you’ll want to carefully review it during your due diligence process.
The FDD, Item 19, and franchise financial information
Financial performance representations can take a variety of forms. They include any statement that promises that a prospective franchisee will be able to achieve a specific financial goal. Statements regarding potential sales, income, or profits are financial performance representations.
Financial performance disclosures can be found in Item 19 of the FDD. They are the only disclosures that are optional for franchisors. When a franchisor chooses not to make a financial performance representation, it must state so clearly in its FDD.
If the franchisor you are researching does not make financial performance representations in its FDD, never fear. There are other ways to search for financial data. Make sure to ask existing and former franchisees in the system for information regarding their own historical performance. Their contact information will be listed in Item 20 of the FDD. Note that franchisees are generally not subject to the same restrictions as the franchisor that govern the sharing of financial information.
What financial performance information can the franchisor provide you?
When a franchisor does provide a financial representation, it must first disclose that same specific information within Item 19 of its FDD. In other words, the franchisor cannot provide any specific financial information during the sales process unless it has previously disclosed that same information within Item 19 of its FDD. If the franchisor chooses not to include financial performance representations in its FDD (which is permissible), it cannot provide prospective franchisees with any information on sales or earnings.
So, this all means that thanks to federal regulation, many franchisors will provide you information on their franchise’s past performance. Make sure to evaluate it carefully, as well as the information you gather through talking with existing franchisees, in order to prepare your own financial projections.