If today is the day you decide to franchise your business, you should know that you will be required by law to provide prospective franchisees with a legal document known as a Franchise Disclosure Document (FDD). Item 19 – the section that provides a representation of future financial performance – is often said to be the most important part of the entire FDD, but not everyone thinks it should always be included. There are good arguments to be made on both sides, so let’s try to shed a little more light on the importance of a transparent Item 19.
What is the Franchise Disclosure Document?
A comprehensive franchise disclosure document (FDD) is crucial to your business. It’s the primary source of information about your franchise model and must be provided as part of the pre-sale due diligence process. Its 23 sections cover everything from the history of the franchise, to trademarks, patents and copyrights, to any pending litigation that might impact the financial stability of the franchisor.
Item 19 – entitled “Financial Performance Representations” – is the section of the franchise disclosure document that sets expectations for potential future earnings. It’s usually thought of as the item that answers investors’ number one question: “How much money can I potentially make with this franchise?”
Benefits of a Transparent Item 19
Item 19 paints a picture of just how profitable a franchise might be. A strong Item 19 will include data about top line revenues from other franchise operations, which are sometimes broken down to show high, low, average and median performance. Some franchisors go further and show profitability figures in order to provide a more complete picture of actual financial results. That said, no one can predict the future and business conditions can be beyond the franchisor’s control, so setting realistic expectations is crucial.
Including Item 19 in the FDD when you franchise your business can be important to establish immediate trust and credibility. When it comes to choosing your franchise over other business opportunities, franchisees appreciate full transparency. Above all else, franchisees want a clear idea of how much they must invest, and what their investment is likely to yield.
Why Wouldn’t You Include Item 19 When You Franchise Your Business?
There is a school of thought that says sometimes it’s best not to include Item 19 in your franchise disclosure document. Since it’s not required by law, there’s no reason that you must, but there are usually specific circumstances that would lead you to exclude it from an FDD.
If your franchise business if very new and you only have a few data points, for example, you might not want to extrapolate future results. If most of your franchises are in large cities and you’re expanding into less populated rural or suburban markets, past performance might not be a good indicator of future success. Sometimes company-owned operations with highly experienced management teams can also skew results. If you do include Item 19, be sure it presents as clear and accurate a picture of real financial results as possible.
Accurate Franchising is one of the only franchise development consulting firms that actually owns and operates our own franchise brands. We know from experience that whether or not to include Item 19 in an FDD can be a complicated issue, with numerous factors to consider.
Let Accurate Franchising help answer even the toughest questions about how to start your own successful franchise journey. Contact us today.