Don't let a franchisor's decision not to disclose earnings figures discourage you. There are ways to find out what you need to know.
There is one aspect of buying a franchise that will puzzle you.In fact, you won't believe it the first time you confront it.It defies business logic and runs counter to common sense. Itdrives franchisors crazy and frustrates state regulators so much,they want to fundamentally alter their franchise laws.
It's information about the financial performance of thefranchise, otherwise known as "earnings claims."
No other issue in the world of franchising has drawn moredebate, sparked more legal action or caused more head scratching.The awkwardness of earnings information regulation has led mostfranchise companies to perform a distinctly Victorian dance whenprospective franchisees ask: "How much money can I make withthis franchise?"
These words are an immediate signal to the franchisor thatit's time to strike up a minuet on the ol' harpsichord."We can't tell you," says the franchise rep throughclenched teeth. "You'll have to ask our currentfranchisees that question (pause for understated courtesy to yourpartner), and work up your own financial projections (bow deeply atthe waist, flourish left arm)."
Wait a minute! In your mind, this is the most important questionof all. It's the question on which will swing one of the mostimportant financial decisions of your life. "Why should I buythis franchise if I don't know whether it will make money forme?" To be told the franchisor can't help you answer thisquestion can be a shock. Isn't this where the real franchiseselling begins?
"OK," you say, "I understand you can't make aperformance projection because, after all, no one really knows howI will do and there are too many variables to count. How about ifyou just share some neutral, factual information with me? Tell methe gross sales for each of your units last year, based on theroyalties the company received. You should have that information atyour fingertips, right?"
A well-schooled franchisor will continue the dance until themusic stops. "I'm sorry," the rep pleads,"you'll have to get the answer to that question from ourfranchisees themselves. You'll find a list of their names,addresses and phone numbers in Item 20 of our Uniform FranchiseOffering Circular."
What's going on here? Franchise law allows the franchisor todeliver earnings information if the company also provides it in itsdisclosure document. In a Uniform Franchise Offering Circular, thisinformation is presented in Item 19. However, studies have shownthat only about 25 percent of all franchisors choose toinclude any information about earnings.
Why so few? Some companies simply don't want you to have theearnings information for their system because it paints anunflattering picture and discourages future franchise sales. Othersmay be concerned about the litigation implications of deliveringperformance information, or they may not have enough reliableperformance data.
Whatever the reason, the absence of earnings information putsyou at a disadvantage. The only answer is shoe leather. This isyour part of the dance. Get in the car, and visit as many owners asyou can; get on the phone and call others. Even if the franchiseyou're evaluating provides earnings information, still reachout to franchisees. There's no better source of reliable,firsthand data about a franchise system. Ask them about thefinancial performance of their units. The larger the sampling offranchise owners you talk to, the more reliable the information youglean will be.
Take the performance data you gather to a competent accountant,and work up a solid set of projections, showing break-even figuresand projected profits and losses. You can make a truly informedfranchise purchase decision after you complete the earnings claimsdance.
Andrew A. Caffey is a practicing franchise attorney in theWashington, DC, area; a former general counsel of the InternationalFranchise Association; and an internationally recognized specialistin franchise and business opportunity law.E-mail him at ACaffey@compuserve.com
Though getting earnings claims out of most franchisors is likepulling teeth, some may choose to reveal this information, eitherofficially or off-the-record. When you receive earningsinformation, how do you handle it?
- Carefully review the company's statements in Item 19 of theUniform Franchise Offering Circular (UFOC). Here, the franchisor isrequired to describe the facts and assumptions underlying theearnings claim. It typically states whether the claim is based onactual experience as well as the percentage of franchiseesoperating during the specified period who actually attained orsurpassed the claims.
At the end of all Item 19 earnings statements is a requireddisclosure that reads something like this: "Substantiation ofthe data used in preparing this earnings claim will be madeavailable to the prospective franchisee on reasonablerequest." If you don't understand the earnings statementor if it doesn't strike you as realistic, request to see thesubstantiation. Make your request in writing, and don't expectan immediate answer. Under franchise law, you have a right toreview the substantiation.
- Compare the earnings claim against information you'vegathered from franchisees, or show it to them and ask if it'saccurate in their experience. If it's exaggerated ordoesn't represent the real results in the system, take thatinto account when evaluating the purchase.
- Are the statements made by the company's sales reps inaccord with the Item 19 disclosure? If not, move cautiously, andconfirm the information for yourself.
- If you come across a problem with the earnings claim, or youdiscover the franchisor has been disciplined in the past for itssales practices, you may want to review the earnings statement witha closer eye. Make a point of obtaining independent verification,like visiting with franchisees. What percentage of franchisees inthe system have done as well as the stated claim? Is it amajority?
There is a movement among the franchise registration states tomake the delivery of earnings performance information mandatory.The Federal Trade Commission has resisted this effort on policygrounds, setting up one of the more interesting policy debatesfranchising has seen in years. Observers don't expect thisthorny issue to be resolved in the near future.