Wednesday, September 7, 2016

Franchise Disclosure Document - Dissected - Part Four

Now for the wrap-up of this series of posts. (If you missed Part One, Part Two, or Part Three, you can click on the hyperlinked text)

Although we could focus on many of the remaining FDD Items, Item 19 - Financial Performance Representations deserves our attention. Franchisors need to get it right and franchisees need to understand their right to additional information.

Before 2007, this item (under the old UFOC format) was labeled "Earnings Claims" and was much stricter than today's version. To encourage more franchise systems to provide financial performance information, the rules were loosened. Now, the Amended FTC Rule "permits a franchisor to provide information about the actual or potential financial performance of its franchised and/or franchisor-owned outlets, if there is a reasonable basis for the information, and if the information is included in the disclosure document." As a result, this disclosure has been given a wide berth.

When we dissect the language, we see that the information can simply be "potential" performance if there is a reasonable basis. Now the FTC Compliance Guide carries a section on the "Reasonableness of a Financial Performance Representation" (p.135) that I will let interested readers review on their own; but I want to focus on another requirement of Item 19.

To make a proper disclosure in compliance with the Rule, in addition to having a reasonable basis, a franchise system must have "written substantiation for the representation at the time the representation is made." However, in the FDD, a statement indicating that "written substantiation for the financial performance representation will be made available to the prospective franchisee upon reasonable request," need only appear. The FTC Compliance Guide notes that written substantiation means that the franchise system must have "supporting data underlying any representation..."

Much more could be said about the Item 19 requirements (see the Amended FTC Rule and the FTC Compliance Guide) but the take-away here is: franchisors must have the underlying data ready to produce and franchise-buyers should ask for it.

Although I must say in my years of practice, I have found that franchise-buyers are hesitant to request the information even when counseled to do so! Why? They don't want to appear uncooperative or distrustful. Maybe franchisors should be more aggressive in offering the data? After all, its supposed to be the reasonable basis on which buyers are encouraged to buy into the system!

The End!

1 comment:

  1. At we've found a direct correlation among the top performing or healthy franchise systems and the quality and detail contained in their Item 19 disclosure.