Understanding Franchise Earnings Disclosure or Item 19
At some point during the franchise acquisition process the franchisor will furnish the prospective buyer with their FDD – the franchise disclosure document.
Franchisors are required by law to provide this document which lists virtually everything pertaining to the franchise operations down to the smallest detail. Any ongoing lawsuits will require to be disclosed, the companies financial history,as well as an accounting of estimated costs to be incurred by the franchisee and more.
The item 19 found within the FDD is the section where the franchisor can provide earnings disclosure. Not all franchisors do so and it is not required by law. Up until this point any franchise company or broker is prohibited to make any earnings claims. This can be frustrating for investors who want to immediately know “how much can I earn with your franchise” however that information will not be furnished until later in the discussions.
Once the Franchise Disclosure Document has been received the prospective franchisee then has a minimum of 14 days to examine the FDD before they are legally permitted to make the franchise buying decision or sign any contracts.
Many franchisors will stress the fact that they have a “strong item 19” however it is important that the franchise buyer understand that the franchisor can present these numbers in any way they wish.
For example a franchise could present only one a geographic segment that has had historically high earnings such as ice cream sales in Southern markets while omitting their lower earning Northern locations. They could select the top 25% of the franchisees and eliminate the lowest earners. There is no requirement to present all of their operating franchisees combined with an overall average of their earnings.
There are some franchises that have disclosures indicating a large percentage of 7 figure earners in their ranks. Obviously this information can and does emotionally influence individuals who subsequently suspend their critical thinking and focus only on that “million bucks”.
But how long has it taken those top earners to get there? What is their net revenue vs gross? Some industries have disproportionate operating costs. Where are they located? What was their background? Some franchisees have career backgrounds that give them a huge edge in their specific industry.
When encountering the item 19 during the franchise acquisition process it is important to ask questions. What data has been eliminated and why, how are the low earners doing and why. The item 19 is only a small part of the due diligence process when buying a franchise along with effective validations, S.W.O.T analysis, and extensive online research.