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FINANCIAL PERFORMANCE REPRESENTATIONS

Disclosing Item 19 Financial Performance Representations

FranSource helps franchisors complete every aspect of the FDD, including their approach to sharing the financial performance of their franchise and/or corporate affiliated locations in Item 19 of the FDD.

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Franchise Rule

Under the Franchise Rule, the FTC grants franchisors the ability to share information about the actual or potential financial performance of its franchised and corporate affiliated locations in Item 19 of the FDD (“Financial Performance Representations). Information may differ as to what is provided in this section, only if:

  1. a franchisor provides the actual records of an existing outlet an individual is considering buying; or
  2. a franchisor supplements the information provided in Item 19, for example, by providing information about possible performance at a particular location or under particular circumstances.
Item 19 Financial Performance Representation Illustration of Man Sitting in Front of His Franchise Company

Omitting Item 19 Financial Performance Representations

There are reasons why a franchisor may choose to exclude any financial performance representations. One rationale is to mitigate legal risk. If franchisees underperform, franchisors can be subject to legal action using claims and data provided in Item 19. Similarly, a franchisor with limited data or an evolving franchise system may feel emerging franchisees will only have a negative perception of the brand in its growing state.

If Item 19 financial performance representations are omitted, franchisors are required to make a clarifying statement to prevent interference from external sources: “We do not make any representations about a franchisee's future financial performance or the past financial performance of company-owned or franchised outlets. We also do not authorize our employees or representatives to make any such representations either orally or in writing. If you are purchasing an existing outlet, however, we may provide you with the actual records of that outlet. If you receive any other financial performance information or projections of your future income, you should report it to the franchisor's management by contacting [name, address, and telephone number], the Federal Trade Commission, and the appropriate state regulatory agencies.”

Conditions for Incorporating Item 19

On the other hand, incorporating Item 19 financial performance representations can be a tactical sales tool. Prospective franchisees who receive an inside look into the potential profitability of the business are more likely to feel confident in their decision to purchase a franchise, which in turn, lays the foundation for a trusting long-term partnership.

Franchisors who choose to provide financial performance representations are required by the FTC to provide reasonable basis and written substantiation to verify the financial performance representations in Item 19. Franchisors must also include:

  1. Whether the representation is an historic financial performance representation about the franchise system's existing outlets, or a subset of those outlets, or is a forecast of the prospective franchisee's future financial performance.
  2. If the representation relates to past performance of the franchise system's existing outlets, the material bases for the representation, including:
    • Whether the representation relates to the performance of all of the franchise system's existing outlets or only to a subset of outlets that share a particular set of characteristics (for example, geographic location, type of location (such as free standing vs. shopping center), degree of competition, length of time the outlets have operated, services or goods sold, services supplied by the franchisor, and whether the outlets are franchised or franchisor-owned or operated).
    • The dates when the reported level of financial performance representation in Item 19 was achieved.
    • The total number of outlets that existed in the relevant period and, if different, the number of outlets that had the described characteristics.
    • The number of outlets with the described characteristics whose actual financial performance data were used in arriving at the representation.
    • Of those outlets whose data were used in arriving at the representation, the number and percent that actually attained or surpassed the stated results.
    • Characteristics of the included outlets, such as those characteristics noted in paragraph (3)(ii)(A) of this section, that may differ materially from those of the outlet that may be offered to a prospective franchisee.
  3. If the representation is a forecast of future financial performance, franchisors must state the material bases and assumptions on which the projection is based. The material assumptions underlying a forecast include significant factors upon which a franchisee's future results are expected to depend. These factors include, for example, economic or market conditions that are basic to a franchisee's operation, and encompass matters affecting, among other things, a franchisee's sales, the cost of goods or services sold, and operating expenses.
  4. A clear and conspicuous admonition that a new franchisee's individual financial results may differ from the result stated in the financial performance representation in Item 19.
  5. A statement that written substantiation for the financial performance representation will be made available to the prospective franchisee upon reasonable request.
  6. A franchisor does not need to comply with these standards if the franchisor only wishes to disclose results from operations at the specific location offered for sale. In these scenarios, financial information should only be given to prospective purchasers of the outlet.

The franchise operator can also supply financial performance representations for a particular location in addition to information covering the existing franchise system, or one of its subsets. These numbers should be presented outside the Item 19 financial performance representations disclosure as a supplemental material. To comply with the FTC Franchise Rule, it must:

  • Be in writing.
  • Explain the departure from the Item 19 financial performance representation in the disclosure document.
  • Be prepared in accordance with the requirements of paragraph(s) (3)(i)-(iv) of this section.
  • Be furnished to the prospective franchisee.
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