FDD's Item 19 Can Help You Decide If You Should Buy a Franchise

There has been a growing trend in the world of franchising to tell candidates more about their earnings potential. Item 19 in the Franchise Disclosure Document (FDD) is the section that provides details on earnings, costs, and other factors likely to affect future financial performance after a candidate signs on to become a franchisee.

Today's franchisee prospects have become increasingly sophisticated in their search process, with more and more looking for hard numbers to give them deeper insight into the earnings potential of a franchise brand. Some franchisors provide these earnings claims (now called financial performance representations, or FPRs); others refrain, concerned about the legal liability of making such claims. But, when done properly, FPRs provide a competitive edge as a sales tool for the franchisor. Providing straightforward, valuable financial data to prospects goes a long way toward developing trust.

Fred Harms is vice president of development at Kiddie Academy (92 units open and 63 in various stages of development), and says this is what he likes to tell prospects when discussing his company's FPR: "Look, this is your average ROI EBIDTA. It ranges from a low of this to high of this, and low is really horrible. You have some unprofitable franchisees. Are you better than average? I can tell you how to be." In the sales process, he says, Item 19 is the franchisor's response to the question on every candidate's mind: "How much money can I make?"

Charlie Simpson, executive vice president and COO of Great Clips says if you can tell prospects what it costs but not how much they can make, the response usually runs something like: "What do you have to hide? The other five companies will tell me. Why not you?"

When your franchise is solid, says Simpson, "An earnings claim is an opportunity to showcase your company. It provides instant credibility with a candidate because you have one."

And, he says, it's critical for franchise prospects to read the FDD completely. "When they get this document, first of all, the biggest advice is 'You really should read it.' I know from experience that most candidates don't," says Simpson.

If you get an FDD and there is no Item 19, he says, ask a very direct question: Why not? "How they respond to that will you give you a glimpse of the integrity and the sustainability of that franchise."

Perhaps the most important benefit of Item 19 is to give candidates the information they need to create a realistic scenario about what lies ahead if they sign--not only of their potential ROI, but of what's required to achieve that in their market. Disclosing earnings information also expedites the decision process. Without an FPR it could take months before a candidate finally figures out if that franchise is the right fit for them or not.

Gary Robins, a successful franchisee who owns 30 Supercuts and Cost Cutters salons in Pennsylvania and New Jersey, knows a thing or two about earnings claims. "I certainly like agreements with earnings claims more than agreements without them," says Robins, "I use them to analyze the business risk and the return on investment."

Robins says he's always looking for good opportunities--not one or two units, but 10 or 20--so he examines the "context" of the numbers presented in Item 19. "You need to understand what you're looking at--sales, not expenses, and the class of stores they're giving you." For example, if a brand has 500 stores, he might be looking at a sample of 100 stores open 5 or more years; that is, their most mature, successful stores. "You have to look closely at the data," he advises.
As an experienced reader of FDDs, Robins says he is seeing more sales data disclosed than in past years, but many franchisors are still leaving expense data out of their Item 19 numbers. "I guess it's helpful, and a step in the right direction," he says.

"Whether there is an earnings claim in the agreement or not, I have to get insight into the business model--whether through an earnings claim or looking at franchisee financials," he says. "I would not proceed without having a direct earnings claim or an indirect earnings claim."

Financial performance representations help present a realistic--and detailed--picture of the likely road ahead for franchise candidates. Make sure you take a hard look at the road map before setting out on your journey as a franchisee.

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