Franchise sales compliance is an essential part of protecting and growing a franchise system. From financial performance representations to franchise broker communications, what your sales team says to prospective franchisees can create significant legal exposure if it falls outside the requirements of federal and state franchise laws.
Prospective franchisees understandably want to know how much money they can make, what their investment may look like, and whether the business is financially viable. However, the Federal Trade Commission's Franchise Rule establishes requirements governing how franchisors communicate financial performance information during the franchise sales process.
Understanding these requirements helps franchisors maintain compliant sales practices, reduce legal risk, and provide prospective franchisees with the information they need to evaluate the opportunity.
What Can Franchise Sales Teams Legally Say to Prospective Franchisees?
Franchise sales representatives can discuss the brand, business model, initial investment, training, operational support, and other aspects of the franchise opportunity. However, when conversations turn to potential revenue, profitability, or financial returns, specific legal restrictions apply.
Under the FTC Franchise Rule, financial performance representations generally must be supported by written substantiation and properly disclosed in Item 19 of the Franchise Disclosure Document (FDD). Sales representatives should not independently provide financial projections, discuss earnings outside the authorized disclosures, or make promises about a prospective franchisee's potential financial performance.
Franchisors should establish clear guidelines for what their sales teams can communicate, including:
- Financial Performance: Only discuss financial results within the scope of the franchisor's properly disclosed Item 19, subject to applicable legal requirements.
- Initial Investment: Explain the estimated startup costs and investment requirements disclosed in Item 7 of the FDD.
- Training and Support: Describe the training programs, operational resources, and ongoing assistance available to franchisees.
- Franchisee Validation: Encourage prospective franchisees to speak with existing franchise owners and conduct independent due diligence.
What Is Item 19 and Why Is It Important for Franchise Sales Compliance?
Item 19 of the FDD governs financial performance representations, including statements about actual or potential sales, income, revenue, and profits. When properly prepared, Item 19 allows franchisors to provide prospective franchisees with historical financial data and other financial performance information that complies with applicable disclosure requirements.
A compliant Item 19 must have a reasonable basis, be supported by written documentation, and clearly explain the information being presented. Depending on the franchise system, it may include average gross sales, median revenues, operating expenses, or other relevant financial metrics.
Franchisors should regularly evaluate whether their Item 19 accurately represents their franchise opportunity. If prospective franchisees consistently ask financial questions that the current disclosure does not answer, it may be time to review whether additional financial information can be properly incorporated into the FDD.
Can Franchisors Provide Pro Formas or Financial Projections to Prospective Franchisees?
One of the most common questions franchisors ask is whether they can provide prospective franchisees with a pro forma or financial model to help estimate potential revenues, expenses, and profitability.
Although the FTC Franchise Rule permits certain properly supported financial forecasts and supplemental representations under specific requirements, our firm's general recommendation is to avoid distributing separate pro formas, including blank financial models. Even when a franchisor does not provide the underlying assumptions, these documents can create legal exposure if sales representatives help prospective franchisees complete them or suggest financial expectations.
The concern extends beyond whether a financial model is technically permissible. If a franchise relationship later becomes disputed, a pro forma may be used as evidence of alleged financial promises or misleading projections. Franchisors should instead focus on developing a complete, accurate, and properly substantiated Item 19 disclosure.
Why Financial Claims Outside Item 19 Create Legal Risk
A financial performance representation does not have to be intentionally misleading to create a compliance problem. Even an accurate statement about a successful franchise location can violate applicable disclosure requirements when communicated outside the legally permitted framework.
For example, a sales representative might tell a prospective franchisee that the brand's highest performing locations generate more than $1 million in annual revenue. If that statement is not authorized under the franchisor's Item 19 and applicable rules, it may constitute an improper financial performance representation, regardless of whether the information is true.
Franchisors should be particularly careful about:
- Verbal Representations: Discussing specific revenues, profits, or expected returns during sales calls or meetings.
- Selective Financial Data: Highlighting favorable results from individual locations without the appropriate disclosures and context.
- Financial Calculators: Using selected Item 19 figures to help prospects estimate profits or investment returns.
- Marketing Claims: Publishing franchise development materials that communicate financial performance beyond what is legally authorized.
Are Franchisors Responsible for What Franchise Brokers and Sales Organizations Say?
Many franchisors rely on franchise brokers, franchise sales organizations (FSOs), and independent sales representatives to identify and recruit prospective franchisees. However, outsourcing franchise development does not eliminate the franchisor's compliance responsibilities.
Third party sales representatives may qualify as franchise sellers under the FTC Franchise Rule and may be subject to additional state requirements. Franchisors should ensure that these representatives understand the restrictions on financial performance representations, use approved sales materials, and comply with applicable disclosure rules.
A franchise sales compliance program should include:
- Training: Educate internal and external representatives about Item 19, FDD disclosure requirements, and prohibited financial representations.
- Approved Materials: Require brokers and sales organizations to use accurate, authorized franchise development materials.
- Oversight: Monitor sales communications and establish procedures for identifying potential compliance violations.
- Accountability: Clearly define compliance obligations in agreements with outside sales representatives and organizations.
Can Existing Franchisees Share Financial Results With Prospective Franchise Buyers?
Franchisee validation is an important part of the franchise buying process. Prospective franchisees should have opportunities to speak with existing owners about their experiences, the support they receive, and the realities of operating the business.
Existing franchisees may independently discuss their financial performance with prospective buyers in appropriate circumstances. However, franchisors should avoid scripting financial discussions, directing franchisees to provide specific earnings information, or using selected franchisees to communicate financial representations that the franchisor cannot otherwise make.
A franchise system built around strong unit performance and positive franchisee experiences should be able to rely on authentic franchisee validation rather than attempting to influence the financial information prospective buyers receive.
How Can Emerging Franchisors Sell Franchises Without an Item 19?
Emerging franchisors often lack historical franchisee financial data, particularly when they are selling their first few franchises. Although the FTC Franchise Rule generally does not require franchisors to make an affirmative financial performance representation in Item 19, the absence of that information does not permit unauthorized financial claims.
Instead of relying on projected earnings, new franchisors should communicate the strengths of their business model, brand positioning, operational systems, training programs, and franchisee support. They should also prioritize recruiting qualified franchisees who understand the business and have the resources necessary to operate successfully.
For emerging franchise systems, the early stages of development should focus on establishing successful locations and building authentic franchisee validation. A strong foundation of operating franchisees will ultimately provide greater long term value than simply maximizing the number of initial franchise agreements signed.
How Can Franchisors Strengthen Their Franchise Sales Compliance?
Effective franchise sales compliance requires coordination between franchise leadership, legal counsel, finance teams, and everyone involved in franchise development. It should be part of the franchisor's ongoing operations rather than a process addressed only during annual FDD renewals.
Franchisors should regularly review their disclosure documents, train sales representatives, oversee third party development partners, and evaluate whether their financial performance information accurately reflects the franchise opportunity.
Key practices include:
- Review Your FDD: Ensure the FDD remains accurate and that material changes are evaluated promptly with franchise counsel.
- Evaluate Item 19: Determine whether the financial performance information is properly supported, representative, and useful to prospective franchisees.
- Monitor Sales Communications: Review marketing materials, presentations, broker communications, and sales procedures for potential compliance issues.
- Track Disclosure Requirements: Maintain reliable records of FDD delivery, applicable waiting periods, and state franchise registration requirements.
- Address Issues Early: Consult franchise legal counsel when potential unauthorized representations or other compliance concerns arise.
Ultimately, the goal is not simply to prevent violations. It is to create a franchise development process that attracts qualified franchisees, communicates accurate information, and supports the long term growth of the franchise system.
Is Your Franchise Sales Process Compliant? Our franchise attorneys help franchisors navigate FDD disclosures, Item 19, and franchise sales compliance requirements.
Frequently Asked Questions About Franchise Sales Compliance
Franchise sales representatives generally may discuss properly disclosed financial performance information in Item 19, subject to applicable requirements. They should not make unauthorized statements about anticipated revenues, profits, or investment returns.
A blank pro forma may still create compliance risk, particularly if a sales representative provides assumptions or helps the prospective franchisee complete the model. Our firm generally recommends against using separate pro formas during the franchise sales process.
Franchise brokers and other franchise sellers must comply with applicable franchise sales laws. They generally cannot provide unauthorized financial projections or earnings claims outside the permitted disclosure framework.
Generally, financial performance representations must comply with Item 19 and applicable legal requirements. Limited exceptions exist, including certain supplemental representations and actual operating records for existing outlets being sold. Franchisors should consult franchise counsel before providing additional financial information.
Prospective franchisees can independently use AI tools to develop financial models, but those models may contain unsupported assumptions or inaccurate projections. Franchisors should avoid endorsing or correcting AI generated financial projections in a manner that creates unauthorized financial performance representations.
Under the FTC Franchise Rule, franchisors generally must provide the current FDD at least 14 calendar days before a prospective franchisee signs a binding agreement or makes a payment in connection with the franchise sale. Additional federal and state requirements may apply.
