As a franchisor, you know how critically important your Item 19 Financial Performance Representations (FPR’s) are for franchise sales. Below we get into why now is the best time to improve your FDD Item 19 and disclose as much information as possible about your financial data and how COVID affected your sales.
How has COVID Impacted your Sales and Item 19 in 2020 and 2021?
It’s important for you, as a franchisor, to improve your Item 19 so it implements the very best practices in the industry while being transparent to franchisee candidates your financial data. How do you make it compelling when compared to your competition and can actually help your franchise sales?
A little secret… many Item 19’s out there are just not good. Many times, they have limited information about gross sales or other vague and confusing data that isn’t properly defined. So, there are opportunities to be favorable to prospective franchisees.
We believe that after the COVID impact, now is a great opportunity to improve your FDD and Financial Performance Representations.
Disclose More, Not Less
Our recommendation to our clients has been to add more disclosure and more detail to their Item 19’s. Also, state regulators are requiring COVID Impact Statements so franchisee candidates can compare sales performance before, during, and post-COVID.
How to Improve Your FDD Item 19: The Basics
Some important rules for Financial Performance Representations are:
- FPR’s may only be disclosed by a Franchisor in FDD Item 19
- FPR’s may include “historical representations”, i.e., how much franchisees have earned in the past.
- FPR’s may include “projections”, i.e., how much an individual prospective franchisee is likely to earn in the future. Note: If using Projected Performance, you have to be extremely cautious and consult with your legal and accounting team.
- Franchisors must possess a reasonable basis that the FPR is “representative of the franchise offering”.
- Requires disclosure of (a) measurement periods, (b) distinction between Company Owned Outlets and Franchised Outlets, (c) and a narrative about the data sets, common attributes among the Outlets that achieved a stated level of performance, and other material information that the franchisor is relying on.
The FTC defines a FPR 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.”
Impact of COVID on Your Business
For most franchisors, COVID has impact operations in many ways, including:
- Modified Operations; e.g., Take-out only, safety protocols, limited capacity
- Supply chain disruption
- Increased costs
- Employee retention and hiring
- Reduced gross sales
- Increased gross sales
Based on the NASAA Guidelines, whether a franchisor can use a historical FPR in 2020 and beyond depends on:
- Whether the franchise business has been significantly impacted by the COVID-19 pandemic
- The type of data the franchisor includes in the FPR
- The reasonable inferences a prospective franchisee can draw from the FPR
- When the franchisor estimates a prospective franchisee can expect to open for business after entering into a franchise agreement
- Whether and how the franchisor adapts the franchise business to account for current market conditions
- resulting from the COVID-19 pandemic
- Whether and how the franchisor adapts the franchise business to account for future market conditions resulting from the COVID-19 pandemic
What a Quality Post-COVID Item 19 Looks Like
1. Start with a Narrative
Describe how the pandemic impacted your operations, closures, modified operations, limited capacity, and most importantly, sales.
2. Create Definitions
For example, if you’re going to include “Adjusted Profit”, make sure you give a clear definition. If you use a call center, show that data too.
3. Add Detail about your Calculations
For service-based businesses, add Gross Sales less Costs of Goods Sold, i.e., materials, equipment, labor. For restaurants, add Gross Sales less Food Cost and Labor Cost to get to a Gross Profit calculation.
Having complete data should be a standard for your franchise sales process. Before you take any steps, consult with an experienced attorney to help craft your FDD Item 19.
Call our team at (800) 976-4904, by contacting us or web chat, to learn more about how we can help you improve your Franchise Disclosure Document and Item 19.