Part 6: Breaking Down the FDD

Man drawing graph

SPECIAL SECTION: PART 6

Breaking Down the FDD

Item 19: Financial Performance Representations

by Nicole Micklich

All prospective franchisees want to be sure they can make money if they buy a franchise. Items 19 and 21 of the franchise disclosure document (FDD) can help prospective franchisees assess the likelihood that they will reach financial success in a system.

Franchisors are permitted, but not required, to include financial performance representations in their FDDs. A financial performance representation is any oral, written, or visual representation to a prospective franchisee that states expressly or impliedly a level or range of actual or potential sales, income, or profits. This includes statements made in the media. Financial performance representations can take the form of charts or tables, or calculations of possible results.

Most often, a financial performance representation simply states a level or range of potential earnings. Such a representation might say, “During 2015 and 2016, 2,020 stores were in continual operation. These 2,020 stores had an average sales of $403,937 for the entire year 2016. A total of 848 stores had sales above this average, and 1,172 stores had sales lower than the average. The median sales for these 2,020 stores was $378,231.” Some financial performance representations use words like “sales volume,” “profit,” and “income.”

Statements from which a prospective franchisee can infer a level of income or profits are also financial performance representations. For example, “earn enough money to buy a new Lamborghini” qualifies as a financial performance representation. On the other hand, puffery is sometimes not a financial performance representation. If a franchisor tells a prospective franchisee that the franchise provides an opportunity to “make a lot of money,” the statement may be considered puffery, and not a financial performance representation. Providing cost data is also not the same as making a financial performance representation. Listing expenses in Item 7 alone does not constitute a financial performance representation.

WHAT’S REQUIRED

Franchisors are not required to make franchise performance representations. If a franchisor chooses to include financial performance representations, the franchisor must have a reasonable basis and written substantiation for the representation. The disclosure must include the bases and assumptions for the representation. Franchisors are prohibited from making representations that are false or unsubstantiated. If a franchisor does not make an Item 19 financial performance representation, the franchisor must not make any financial performance representations outside of the FDD, including in print and online.

Financial performance representations in Item 19 of the FDD can help potential franchisees understand whether a business can be profitable. Many franchisors include average gross sales for units and cost information in their FDDs. Prospective franchisees can also compare the Item 19 disclosures of different franchisors, because the methodology used to calculate the numbers in the disclosures should be consistent.

Item 21: Financial Statements

While franchisors have the option of providing financial performance representations, franchisors are required to include copies of their audited financial statements for the most recent three fiscal years in Item 21 of the FDD. This requirement exists so that prospective franchisees have enough information to analyze financial trends in the system.

Evaluating financial performance representations and financial statements can be daunting and confusing, so a prospective franchisee is wise to seek advice from a franchise lawyer and accountant.

Nicole Micklich is a franchise attorney with Garcia & Milas. Contact her at (203) 773-3824 or email her at nmicklich@garciamilas.com

Man drawing graph

SPECIAL SECTION: PART 6

Breaking Down the FDD

Item 19: Financial Performance Representations

by Nicole Micklich

All prospective franchisees want to be sure they can make money if they buy a franchise. Items 19 and 21 of the franchise disclosure document (FDD) can help prospective franchisees assess the likelihood that they will reach financial success in a system.

Franchisors are permitted, but not required, to include financial performance representations in their FDDs. A financial performance representation is any oral, written, or visual representation to a prospective franchisee that states expressly or impliedly a level or range of actual or potential sales, income, or profits. This includes statements made in the media. Financial performance representations can take the form of charts or tables, or calculations of possible results.

Most often, a financial performance representation simply states a level or range of potential earnings. Such a representation might say, “During 2015 and 2016, 2,020 stores were in continual operation. These 2,020 stores had an average sales of $403,937 for the entire year 2016. A total of 848 stores had sales above this average, and 1,172 stores had sales lower than the average. The median sales for these 2,020 stores was $378,231.” Some financial performance representations use words like “sales volume,” “profit,” and “income.”

Statements from which a prospective franchisee can infer a level of income or profits are also financial performance representations. For example, “earn enough money to buy a new Lamborghini” qualifies as a financial performance representation. On the other hand, puffery is sometimes not a financial performance representation. If a franchisor tells a prospective franchisee that the franchise provides an opportunity to “make a lot of money,” the statement may be considered puffery, and not a financial performance representation. Providing cost data is also not the same as making a financial performance representation. Listing expenses in Item 7 alone does not constitute a financial performance representation.

WHAT’S REQUIRED

Franchisors are not required to make franchise performance representations. If a franchisor chooses to include financial performance representations, the franchisor must have a reasonable basis and written substantiation for the representation. The disclosure must include the bases and assumptions for the representation. Franchisors are prohibited from making representations that are false or unsubstantiated. If a franchisor does not make an Item 19 financial performance representation, the franchisor must not make any financial performance representations outside of the FDD, including in print and online.

Financial performance representations in Item 19 of the FDD can help potential franchisees understand whether a business can be profitable. Many franchisors include average gross sales for units and cost information in their FDDs. Prospective franchisees can also compare the Item 19 disclosures of different franchisors, because the methodology used to calculate the numbers in the disclosures should be consistent.

Item 21: Financial Statements

While franchisors have the option of providing financial performance representations, franchisors are required to include copies of their audited financial statements for the most recent three fiscal years in Item 21 of the FDD. This requirement exists so that prospective franchisees have enough information to analyze financial trends in the system.

Evaluating financial performance representations and financial statements can be daunting and confusing, so a prospective franchisee is wise to seek advice from a franchise lawyer and accountant.

Nicole Micklich is a franchise attorney with Garcia & Milas. Contact her at (203) 773-3824 or email her at nmicklich@garciamilas.com

2019-01-01T02:29:34+00:00