Show the numbers to sell more units
When you are trying to sell franchises, do you show your unit sales results to prospective franchisees? If not, why not? If the reason is that someone told you not to show this information, it is time to rethink that advice.
In the 1990s, only about 30 percent of all franchisors included what was then referred to as “earnings claims” in their disclosure documents. However, prospective franchisees tend to be more sophisticated today than they were decades ago, and are insisting on seeing results of existing outlets.
Perhaps as a result, state franchise examiners report that more than half of all disclosure documents registered in their state today include what are now called “financial performance representations.”
Franchisors that do not show results to prospective franchisees are generally at a disadvantage when prospective franchisees compare offerings. Those franchisors offer various reasons for not giving the information. Some are valid; many are not.
Say it in Item 19
If you do not give out the information because you cannot get reliable information from franchisees and do not have company-owned locations, that is understandable. If you do not give out the information because the numbers are not good, that is also understandable. Of course, both of these situations suggest you have more serious problems that should be addressed before you continue selling franchises.
Many franchisors that do not give prospects information on their existing units report: “My attorney told me not to give out that information.” While system results cannot be presented to prospective franchisees on a paper napkin or “under the table,” they can be presented in Item 19 of your FDD.
Wouldn’t you sell more franchises if you showed prospects how well others have done? As an attorney who advises franchisors on preparing their disclosure documents, I would much rather include these numbers in a disclosure document that has been vetted by management, and by lawyers and accountants who will include the assumptions that underlie the numbers, than learn later that they were provided in a separate handout, which not only violates the law, but also does not include those assumptions, or the permitted disclaimers.
Including a financial performance representation in your disclosure document has fewer risks today than ever before. This is because state regulators are in the process of issuing a financial performance representation commentary, addressing 20 questions about these disclosures that were previously uncertain, and often the subject of litigation.
This “NASAA Franchise Commentary” is expected to be published this September for public comment. The task force that worked on the commentary will then review those comments and finalize the guidance provided in the commentary—it is hoped by the end of this year.
Until that review has been completed and the commentary is formally adopted by the North American Securities Administrators Association, the commentary does not have the force of law. Nevertheless, it provides guidance to franchisors in preparing financial performance representations that will withstand the scrutiny of state franchise examiners and the courts.
Neither current law, nor the commentary, prescribes a specific format in which these numbers must be presented, nor does it dictate the numbers that must be disclosed. Systems seeking to attract unsophisticated franchisees may need to show detailed information that covers revenue, costs and profits. In other systems, prospective franchisees may only be interested in gross sales or gross profit numbers. These numbers are often presented in ranges, showing the number and percentage of franchisees that fall within each range.
For systems that convert existing businesses to their model, the most important numbers are not gross sales or even profits, but the uptick in sales that franchisees have achieved by converting to the franchise system. In some industries, there may be specific benchmarks that are important to prospective franchisees.
In a membership-based system, prospects can compare various systems simply by looking at average or median membership prices, and average and median number of members per unit. Numbers of transactions, the size of an average sale (known as “average check” in the restaurant business) is key in some systems. All of these are permissible forms of financial performance representations.
The key to preparing a useful financial performance representation is to compile information about your system that is important to your prospective franchisees, and that allows you to compare favorably to your competitors.
The law also allows Item 19 numbers to be based on a subset of franchisees—not simply those with the highest sales but those who share non-financial common characteristics. For example, many systems find that franchisees who attend their annual conference or regional training programs have better results than those who do not. If that is true for your system, consider creating a subset of all franchisees who attended the last annual conference and show their numbers in your disclosure document.
The same can be done with those who recently remodeled their stores or added new products or programs that you want others to add as well.
When less than a third of all franchisors were showing financial results to prospective franchisees, franchisors could convince prospective franchisees they did not need this information. Today, with more than half of all franchisors including financial results in their disclosure documents, the exclusion of these results is likely to negatively impact franchise sales.
Since the only way to legally provide financial results for the system is to include this information in Item 19 of your disclosure document, it is time for most brands to rethink their decision not to include these numbers, and to add key unit financial results to their disclosure documents.
Charles Modell is a franchise attorney with Larkin Hoffman in Minneapolis and has represented franchisors for nearly 40 years. He is also a member of the NASAA task force that has been working on the new financial performance representation commentary. Reach him at email@example.com or (952) 896-3341.