Financial Performance Representations (FDD Item 19)
Item 19 contains claims the franchisor chooses to make about the sales or earnings of its franchises for which there is a reasonable factual basis. The Franchise Rule doesn't require a franchisor to provide sales or earnings information, but most do.
Any claims the franchisor makes about sales, income or profits must be in Item 19. No other spoken or written financial performance claim may be made if it doesn't appear in Item 19. There are two exceptions to this:
1 . The franchisor may provide the actual records of an existing outlet you're thinking of buying.
2 . The franchisor may add to the information in Item 19 . For example, the franchisor may provide information about possible performance at a particular location or under particular circumstances.
Franchisee and Franchise System Information (FDD Item 20)
Item 20 provides charts showing growth and owner turnover in the franchisor's system. If the charts show more than a few franchised outlets in your area have closed, transferred to new owners, or transferred to the franchisor, it could be due to problems with the franchisor's support or because franchises aren't profitable.
Current and Former Franchisees
Look for the required disclosure of contact information for current franchisees and franchisees who have left the system during the franchisor's last fiscal year. Talking to these people may be the most reliable way to verify the franchisor's claims. Visit or phone as many of them as possible to chat about their experiences. Some current franchisees may be reluctant to talk to you if they're having problems. If that's the case, try contacting others on the list.
Some franchisors may give you a separate reference list of franchisees to contact. To ensure you get the full picture, you may want to contact a number of franchisees listed in the disclosure document and some on the separate list.
Talk to several franchisees who have been in business just over one year. They're in the best position to tell you:
- their total investment
- whether they were able to open their outlet in a reasonable time
- whether they were satisfied with the franchisor's training, opening assistance and advertising
- whether the franchisor provided ongoing help and assistance
- whether they have been able to break even
It's also a good idea to talk to several franchisees who have been in business for five years. Ask:
- how long it took them to break even, earn a reasonable income and recoup their investment
- whether the franchisor is providing the services and assistance it promised and fulfilling its
- contractual obligations
- what problems, if any, they are having with the franchisor
- whether they would invest in another outlet
- whether they're satisfied with the advertising program
- whether they are satisfied with the cost, delivery and quality of goods or services they must buy from the franchisor, its affiliates or sole approved suppliers
It's worth tracking down former franchisees (using contact information from Item 20), although some of them may have signed confidentiality agreements that prevent them from talking with you. Prior owners can tell you:
- the problems they had with their outlet
- whether they broke even or made a profit
- when and for how long they operated the outlet
- their business background
- why they left the franchise system
Some franchisors may buy back failed outlets and list them as company-owned outlets. If you're thinking about buying an existing outlet that the franchisor acquired from a prior franchisee, ask to see the financials showing the outlet's actual operating results. The franchisor must tell you who owned and operated the outlet for the last five years. If a franchise has had several owners in a short time, perhaps the location isn't profitable or the franchisor hasn't supported that outlet as promised. Contact as many of the previous owners as possible to learn about their experience operating the outlet that failed.
Associations of a franchisor's franchisees are an important source of information . Franchisors are required to list in the FDD the associations they sponsor or endorse and independent associations that ask to be listed. An association, whether it's sponsored, endorsed or independent, can provide information about the relationship between the franchisor and its franchisees. You may want to ask members of a franchisee association about:
- the kinds of system problems or issues they discuss
- system problems they successfully resolved
- any problems franchisees face in the operation of their outlets
- any problems franchisees have with the franchisor
Financial Statements (FDD Item 21)
Item 21 provides the franchisor's three most recent audited annual financial statements. If you know how to read financial statements, this information will give you a good understanding of the franchisor's financial health. If you don't, it's a good idea to hire an accountant to review the statements and explain them to you. Investing in a financially unstable franchisor is a significant risk; the franchisor may go out of business or into bankruptcy after you have invested your money. An accountant can help you understand whether the franchisor:
- has steady grow
- has a growth plan
- makes more of its income from royalty payments from successful existing franchisees or from the sale of franchises
- devotes sufficient funds to support its franchise system