Franchise investment is full of benefits when both sides of the agreement are handled with care, and the start of the relationship between a potential franchise partner and franchise seller arguably starts with the Franchise Disclosure Document (FDD). Constructed to disclose the ins and outs of operating a franchise with any given franchise system, the FDD offers a break down item by item that franchisees can turn to for better understanding during their preliminary research.
One Item within the FDD often given emphasis, particularly for individuals interested in understanding what they stand to gain when investing in a franchise (which happens to be pretty much every potential franchisee), is Item 19. This section of the FDD focuses on past or future financial projections and representations, if any are provided, so that franchisees can get an idea of how their future investment may progress specifically related to earnings potential.
Franchisors often offer a “negative disclosure” in this section which means that no financial projections or representations regarding future or past financial performance are provided. This in turn often means that franchisees must consider earnings potential based on other factors. The number of franchises providing disclosures in Item 19 is around 25-30 percent according to FDD statistics. Franchisors thus have the option of either offering specific financial projections or not, and whether they do so, along with what information is disclosed, may indicate to the franchisee if that particular franchise system is right for them. Minimizing risks and understanding what earnings may or may not be possible are an important part of due diligence research.
Providing financial projections may in fact help franchisors to better manage potential franchisee expectations. Additionally, straightforward projections rather than negative disclosures can offer a clear-cut look at earnings potential which franchisees are made aware of from the start, eliminating the possibility that franchisees may acquire an alternative picture of potential earnings elsewhere and somehow become dissatisfied with their investment choice leading to litigation. Of course it may be argued that negative disclosure in Item 19 can also manage franchisee expectations, which is usually the aim of omitting such data from the FDD.
Franchisees receiving an FDD without disclosure in Item 19 have the option of assessing earnings potential in other ways, one of the most common being research through discussions with existing franchisees. Whether this avenue of research is satisfactory based on the number of existing franchisees and the information that can be gathered is something every potential franchisee must heavily consider. Smart due diligence research pays attention to Item 19 to assess how a franchisor operates in terms of transparency, why disclosures are or are not provided, and may consider how alternative franchise systems choose to handle Item 19 disclosure.