June 27, 2017
Let’s be frank for a moment. The Financial Performance Representations, item #19 in the FDD, carry serious weight in determining if you purchase a franchise. It addresses the burning question driving every prospective buyer, “How much will I make running this franchise?”
Yet, the complex financial performance representations displayed in the FDD are anything but clear and straightforward. There’s no standard formatting for franchisors to follow, which results in data groupings, categorization, and potentially confusing layouts.
That’s even if the franchisor includes them. Despite the significance in the decision-making process, this section remains optional. That creates an entirely different set of circumstances, which we’ll dive into at the end.
To help you sort through the data, seeing the real story behind the numbers, here is a quick guide on how to read item #19.
You have the right to request backup data, and you should. This is the raw data used to create the financial performance representations. This isn’t to imply that the data you receive isn’t honest or accurate. The vast majority of franchisors do in fact work to insure the integrity of their numbers.
The reason is you need the raw data to draw your own conclusions, as well as to evaluate other store’s profit and loss statements against what you anticipate your costs to be. The rent in a rural area in California will drastically differ from a rural town in Wyoming. You could be facing the difference between rent markets at $1.50 a square foot against $5 a square foot. Don’t be caught unprepared.
State and city laws also impact wage laws, which can make up a large percentage of the overall operating costs. Cities across the nation are setting their own minimum wage, such as Seattle moving toward $15 an hour. This is over double compared to the $7.25 Federal minimum wage utilized in many states.
Lastly, compare market density and metrics from different stores against the area you’ll be opening your store. You will want to compare your territory demographic to both the successful and struggling franchise locations.
Unless you have an accounting degree somewhere in your background, you will want to seek the help of an experienced accountant to review the numbers in depth. Accountants help you infer the overall health of different units, as well as deciphering the real story. How accurate is the franchisor’s suggestion that units become profitable after a few months? What about the long-term projections? Do you have the data to back those numbers up?
Again, this isn’t to say that franchisors are misleading you with numbers. In my experience, they aren’t. This is just to fine-tune your understanding of what the numbers mean for you in your unique territory.
Without including item #19 in the FDD, the franchisor goes into radio silence about financial projections. Legally they cannot give you any indications on what type of returns you can expect to make. Any mentions, even hints or implied earnings, set franchisors up for serious legal consequences. After they outline the initial investment projections, expect to be on your own when it comes to nailing down the dollars and cents for this franchise.
That doesn’t mean you’re going into this decision blind. You have the right to contact current and former franchisees to inquire about their numbers. After all, these are the numbers that would end up in a formal item #19. Work with them to discern projects, as well as validating initial investment costs. I always advise clients considering purchasing a franchise to reach out to these individuals, regardless of if they need to dig into a profit and loss statement. Your due diligence is where you see a glimpse behind the curtain to see the reality of operating a franchise unit.
One question I always encourage clients to ask is, “If you were to do it again, would you buy this franchise?”
Purchasing a franchise will likely be the largest financial investment you ever pursue. Many far exceed the financial commitment of a house. Before you sign on the dotted line, you need to be sure that your investment is solid. That’s where your entire team of experts comes in.
In addition to bringing in an accountant, you will also want an experienced franchise lawyer to ensure you are on solid legal footing going in. This includes examining the FDD with a fine-tooth comb, pointing out areas of concern and reviewing real estate leases. You can’t afford to leave any area of this investment to chance.
As a seasoned franchise lawyer, as well as a part franchise owner, I can help you ensure you’re legally protected going into your franchise career. Contact me today to start your franchise review process.