Evaluating Potential Earnings

You may want to know how much money you can make if you invest in a particular franchise. A franchisor isn't required to disclose information about potential earnings or sales. If it does, the law requires it to have a reasonable basis for the claim when it's made and to include the claim in Item 19 of the FDD. If a franchisor makes a claim that has a reasonable basis, the FDD also must disclose:

  • the source and limitations of data that support the claim
  • any important assumptions on which the claim is based

Be sure to ask the franchisor for written substantiation that supports the claim. The franchisor is required to provide substantiation if you ask. An accountant can help you determine whether the claims are reasonable, and if they apply to how you plan to operate your business. When you review earnings claims, consider:

Is the Earnings Claim Typical for a Franchise in this System?

Suppose a franchisor claims that franchisees in its system earned $50,000 last year. The claim may be deceptive if it doesn't represent the typical earnings of franchisees. The FDD should tell you how many franchises the franchisor has, how many it surveyed to get that figure, and the number and percentage of franchisees who reported earnings at the level claimed.

Average Income

If a franchisor claims that its franchisees earn an average income of $75,000 a year, that tells you very little about how individual franchises performed. Using an average figure may make a franchise system look more successful than it really is, because the high incomes of just a few very successful franchises can inflate the average for all franchisees.

Gross Sales

Some franchisors provide figures for their franchisees' gross sales. These figures don't really tell about the franchisees' actual costs or profits. An outlet with high gross sales on paper might be losing money because of high overhead, rent and other expenses.

Net Profits

Franchisors often don't have data about their franchisees' net profits. If you get profit information, ask if it's based on information from company-owned outlets. Company-owned outlets often have lower costs because they can buy equipment, inventory and other items in larger quantities at lower prices or may own, rather than lease, their property.

Geographic Relevance

Earnings may vary with geography. If a franchisor provides franchisee sales or income figures, ask if any of the supporting data came from franchisees in your area. The FDD should state whether there are geographic differences between the franchisees whose earnings are reported and your likely location.

Franchisees' Backgrounds

Keep in mind that franchisees have different skill sets and educational backgrounds. The success of some franchisees doesn't guarantee success for all.

Reliance on Earnings Claims

Franchisors may ask you to sign a statement - sometimes presented as a written interview or questionnaire - that asks whether you received any earnings or financial performance representations during the course of buying a franchise. If they told or gave you any information about how much your franchise may earn, report it fully on the questionnaire or other statement. If you don't, you may be waiving any right to contest the earnings representations that were made to you and that you used to make your decision to buy.