Larger franchise systems with over 100 locations are more likely to offer financial performance representations (FPR) than smaller franchise systems and of late, the number of detailed disclosures in Item 19 is moving up. Why is financial disclosure in Item 19 of the FDD becoming more important for expansion and why are smaller franchise systems often more reluctant to offer an FPR?
For one thing, the vast majority of those considering entering into a franchise agreement want to know how much profit they can expect when running the business. The 2014 Prospective Franchisees Survey revealed it is the most important factor to respondents when deciding on a franchise.
This simple fact alone is enough to drive up disclosure in the area of financial performance, though franchisees cannot base their plans on revenue disclosures alone without evaluating costs associated with running the franchise, an evaluation that ultimately reveals the profits information that franchisees are often seeking.
Over half of all FDDs last year, at around 68%, featured an FPR instead of choosing to offer a negative representation, which is ultimately declining to offer any financial projections for franchisees interested in their potential future performance.
In previous years, franchisors offered an FPR in Item 19 about 25-30% of the time. Just last year, franchise systems with fewer locations tended to present FPRs less than half of the time, while franchisors with 100+ locations offered FPRs nearly 70% of the time.
With this kind of FPR increase, franchises that opt to avoid disclosing financial information in Item 19 may face stiff competition amidst franchises that are strategically keeping track of and disclosing financial projections. As the number of reputable franchise businesses increases, so does healthy competition that could drive changes in how the FDD is prepared.
For some franchisors, especially newly developed or those operating with fewer locations, omitting an FPR may seem like a safer option than enduring the challenges of organizing one that can be relied upon in the first place.
On the other hand, a more worrisome potential scenario to businesses considering franchising is finding out that franchising may not actually be possible after research clarifying Item 19 reveals a less than appealing profit for future potential franchisees. In any case, new franchises can opt to disclose to franchisees an FPR based on the performance of corporate owned locations prior to the sale and operation of franchised units.
Franchisors weighing the costs and benefits of using an FPR may find that detailed research and verification of the figures and timelines used in the Item 19, though not without expense to assemble, render franchisees more interested in making an investment that they feel good about over time. Alternately, a poorly executed FRP or one that is missing altogether is more likely to promote future grievances and complicate franchise marketing and sales to potential franchisees down the line.