FDD Item 19 Financial Performance Representations
The Importance of Item 19
As a franchisor, issues involving financial performance representations and whether or not Item 19 of your FDD includes financial performance representations will significantly impact the franchise sales process and the type of financial information that you may or may not disclose to prospective franchisees during the franchise sales process. As a franchisor, any information that you provide to a prospective franchisee that states or implies that they may earn a certain level of sales, income or profits constitutes a "financial performance representation". Under the franchise laws, it is illegal to make any oral or written financial performance representation unless such representation is specifically stated and contained in Item 19 of your FDD. Under the Federal Franchise Rule, a financial performance representation is defined as:
Any representation, including any oral, written, or visual representation, to a prospective franchisee, including a representation in the general media, that states, expressly or by implication, a specific level or range of actual or potential sales, income, gross profits, or net profits. The term includes a chart, table or mathematical calculation that shows possible results based on a combination of variables.
From a practical standpoint this means that you cannot discuss any financial information (i.e., about what a franchisee may earn, the revenues or profits that your franchisee may earn, the revenues generated by your corporate location, the profits earned by your franchisees or, even, a pro-forma template to be completed by the franchisee) with a prospective franchisee unless this information is specifically disclosed in Item 19 of your FDD and is made by you based upon a reasonable basis that is supported by written documentation and records.
Factors to Consider About Financial Performance Representations
As a franchisor, when it comes to financial performance representations, some factors that you should consider, include:
- Assume that You are Making a Financial Performance Representation. Based on the extremely broad definition of what a financial performance representation is, you must assume that any and all financial information that you or your sales people disclose to a prospective franchisee falls within the category of a financial performance representation and must be disclosed in Item 19.
- If You Have No Item 19 Financial Performance Representation You Cannot Disclose Any Financial Information. If your FDD does not include Item 19 data then you cannot provide prospective franchisees with any written or oral information about financial performance. This means, among many other things, no information whatsoever about the revenues, sales, gross profits or profits of your corporate locations, your franchised locations or the potential for a franchisees future operations. Likewise you cannot provide prospective franchisees with formulas or spreadsheets for the franchisees to enter hypothetical data or information about the potential performance of their franchise.
- You Can Launch a Franchise With a Financial Performance Representation Based on Your Corporate Location. Even if you are new to franchising and have no franchisees, you can include Item 19 Financial Performance Representations in your FDD that are based on the financial performance of your corporate owned location. Later on, as you add franchisees and obtain reliable data you will have to expand your Item 19 to include both corporate and franchisee data.
- Eventually Including an Item 19 Financial Performance Representation in Your FDD is the Best Course of Action. From both a franchise sales perspective and from a legal perspective, as a franchisor, it is much better to have an Item 19 financial performance representation in your FDD than not having one. The most obvious reason is that if the numbers are good, it will serve as a selling point with prospective franchisees. From a legal perspective by having an Item 19 representation you will be controlling the data and information disclosed to prospective franchisees and you will be mitigating potential claims that either you or your franchise sales team made unauthorized "oral" performance representations to prospective franchisees.
- You Must Have a Reasonable and Documented Basis. When preparing your Item 19 representations, the information that you disclose must be supported by written documentation and based on a reasonable belief on your part. You must maintain this information and ensure that if your representation is ever challenged in the future that you could disclose your records and information.
- There is Flexibility in How You Structure Your Item 19 Representations. When preparing your Item 19 it is important to work with your franchise lawyers and to understand that the franchise laws do give you some flexibility as to the type of information that is disclosed. That is, you could disclose information about gross sales, unit sales, average selling prices and average metrics regarding franchisee performance. However there is a formula to follow and you must adhere to specific disclosure requirements contained in the franchise laws. The key though is to understand that there is a degree of flexibility in how you structure your Item 19.
- Mandatory Disclaimers About Your Financial Performance Representations. Within your Item 19 under the franchise laws you will be required to include mandatory disclaimers. For example, among other disclaimers, you will be required to disclaim that: "…a new franchisee’s individual financial results may differ…", that "…written substantiation for the financial information will be made available to the prospective franchisee upon reasonable request…" and other disclaimers.
There are many reasons why you may elect to not include Financial Performance Representations in your Item 19. However, the key is to understand that over time your goal should be to include financial performance representations and that by doing so you will be mitigating legal exposure and risk. If you don not include financial performance representations in your Item 19, you will be required to include specific disclaimers advising franchisees about Financial Performance Representations and the fact that you have elected to not include any. To learn more out the Item 19 disclaimers to include when you don’t make a financial performance representation, read FDD Item 19 Financial Performance Representations: Mandatory Disclaimers.
If you are in the process of franchising your business, part of the franchise development process should include evaluating and preparing potential financial performance representations to be included in your Item 19. If you would like to learn more about our franchise development process and franchising your business, learn more about our Franchise Launch Program. If you are an existing franchisor and would like to upgrade your FDD and your Item 19 financial performance representations, learn more about our Franchise Counsel Program.