Most people are drawn to owning a franchise because of the potential financial rewards of being members of an established company or franchise system. If a franchise promises a certain profit or other financial information, prospective franchisees will know more about the business model. A realistic view of the return on your investment in a franchise can only be achieved by assessing earnings promises with diligence.
Clarifying Promise of Earnings
Item 19 in the Franchise Disclosure Document (FDD) mentions a franchisor’s promise of earnings or other financial performance representations (FPR). Such promise must be backed by evidence. The claim must also include:
- The source and limits of the supporting data
- Assumptions used to make the claim
Data must back a guarantee of earnings as available. For example, only a few franchises may provide earnings statistics (e.g., gross sales, profit, etc.). The statistics could come from different geographic or socioeconomic demographics than your franchise opportunity. Last but not least, the FPR may work with assumptions about sales figures or other aspects of the company’s operations.
Data for Clarifying Promise of Earnings
Franchising companies may paint the opportunity positively by using metrics that portray it in its most favorable light. However, to set realistic expectations for a franchise investment, franchisees should thoroughly examine the relevance or value a promise of revenue has to the business. FPRs are a good source for such information.
The Median Income
When taken devoid of context, an average income can be deceiving. An analysis of the participating franchises may be relevant to determining the average income value (and any excluded franchises). As a bonus, comparing averages across multiple franchise locations will let you discover if a single site has substantially impacted the overall average size.
An FPR can tell you how much money you may expect to make if you buy a franchise. When relying mainly on sales data, you may not get a clear picture of how much profit you may expect to make. Expenses aren’t included in net profit calculations because gross sales don’t reflect them.
Data on net profits, like income averages, may not be accurate if incomplete or irrelevant information is omitted. If the net earnings come from franchisee-owned facilities, you can include only a subset of franchisees in the net profit totals. A location controlled by the franchisor is likely to have reduced operating costs (e.g., less training requirements, no large capital expenses, and no lease payments because they own the land).
Legal Counsel for When you are Ready
Potential franchisees can make a more informed decision about a franchise opportunity by carefully examining a guarantee of earnings or other franchise disclosures. To better comprehend the disclosures in an FDD before signing a franchise agreement, having an attorney help you vet the promise of earnings will be useful.