How to Understand a Franchisor’s Financial Performance Representation

By Michael Seid, Managing Director, MSA Worldwide

Prospective franchisees are still often surprised to discover that some franchisors don’t include a Financial Performance Representation in their Franchise Disclosure Document (FDD). The good news is that more and more franchisors are making this important disclosure, with upwards of 60% of franchisors today including some form of Item 19 – Financial Performance Representation – in their disclosure documents. The likely reason for this improvement in franchisor disclosure is that banks now require them prior to granting loans to many prospective franchisees.

When enough prospective franchisees became unable to secure loans and thus become franchisees, franchisors saw the light and provided information sorely missing from many disclosures for many years.

While the format and types of earnings claims information provided by different franchisors vary greatly – even for those within the same industry segment – in general, most FPRs will contain information on several key areas including specific levels or ranges of sales at their locations, information on costs, statistical data about their operations, and other important financial information.

Even if the information is provided, it is important to recognize that it is never a claim of what you will earn. The brand may not be as well known in your market; your location may not perform as well as others in the franchise system; your costs for rent, staff, advertising, and even cost of goods may be different than what is shown in the information provided to you in the FPR.

Most, if not all, Financial Performance Representations will also include explanations and footnotes about specific line items or more detailed facts not included in the financial information. Often, it’s this added information that enables prospective franchisees to localize the information sufficiently for them to develop planning documents specific to their markets and location.

Investing in any franchise is an important decision, and putting together enough accurate information takes effort and time. Use multiple sources to help you make your decision.

Don’t rely solely on the FPR. It is only one point of information, and there is equally important information in the FDD to build upon, including:

• Financial Statements: See if the franchisor has provided information about their company-owned operations in their financial statement or in the notes. If they do, that information is contained in Item 21 of the FDD or as an addendum to the disclosure document.
• Structure of Fees: Not all franchisors base their royalties on a simple percentage of gross sales. Often, continuing fees are based on formulas that may provide sales or other performance information. You’ll find information about fees in Items 5 and 6 of the FDD. While ranges of gross sales for royalty calculations may be provided, remember, that is no assurance you will reach those levels or do so very quickly.
• Investment: Item 7 of the FDD provides information on how much you need to invest to become a franchisee. Typically, this includes a chart of investment as well as information such as size of staff, types of locations, equipment or inventory – a potential gold mine of information from which you can build local projections.
• Other Franchisees: Item 20 of the FDD provides a list of current and former franchisees, with their contact information. Often the most accurate information about unit performance comes from franchisees actually operating a location. Put together a list of questions and call them. MSA’s website provides a free franchise evaluation workbook, Making the Franchise Decision, ​that contains important questions you might not otherwise think of asking.

Other Sources

The Internet provides access to financial information often specific to the franchise you are evaluating. Companies will often post press releases containing information about unit performance; news articles about the company and the industry will often provide useful information. If the franchisor is a public company, review its SEC filings. The quarterly and annual reports can usually be obtained directly from links on the franchisor’s website.

Putting it All Together

Investing in any franchise is an important decision, and putting together enough accurate information takes some effort and certainly some time. You should never rely on only one source to make your decision, especially when so much additional information is available to you. And remember, the franchisor’s disclosure document is only one piece of the puzzle.

If you are not a sophisticated investor, seek the assistance of a franchise attorney, consultant, or accountant to help you evaluate the franchisor’s offering. Experienced professional advisors can help you dig through the data and put together a meaningful projection for your future business.

Franchise brokers may seem like a good source of advice, particularly because their information is provided to you for free most of the time. However, they are likely not a reliable source of assistance because franchise brokers are in the business of selling franchises; they get paid a commission when you invest in one of their franchise client’s franchises and therefore, have a direct financial interest in which franchise you ultimately choose. Even if you work with a franchise broker – and some, like FranNet, have a great reputation for ethically working with their prospective franchise candidates – stick to independent advisors who will be able to provide you with the most unbiased information. You can obtain information about experienced franchise lawyers and accountants from the International Franchise Association’s website at www.franchise.org.