Providing franchise candidates as much financial disclosure as possible can enhance the franchise selection process and prevent future franchisee problems. It can enable franchise candidates to more accurately construct a pro-forma financial statement and cash flow projection.
Under the Revised Franchise Rule, cost and expense data was not considered to be a financial performance representation. This change provided franchisors the ability to disclose expense and cost data, which would help franchise prospects make a more informed decision. The previous regulations were strict and somewhat ambiguous when it came to financial disclosure which provided franchisors the ability to limit the amount of financial disclosure they provided.
There are 2 Items in the FDD that provide franchisors discretion when providing financial disclosure. In some cases, this information is limited in order to enhance franchisee recruitment and closing deals.
The 2 Items are:
Item 7 Franchisee’s Initial Investment, which contains the table and footnotes regarding the franchisee investment, may be used by some franchisors to make the franchise more attractive by underestimating the investment. Since the minimum and maximum amounts in Item 7 are estimated, a franchisor may show costs at the lower range in order to make the investment more appealing to franchise prospects. An area often understated is the last category in Item 7 Additional Funds or Capital. This is an estimate of the funds a franchisee may need to meet certain personal expenses during their start-up phase. This is an area where the amounts should be based upon realistic estimates and not the minimal amount. A number of franchisors use 4-6 months of additional funds rather than the minimum 3 month’s estimate.
Item 19 Financial Performance Representations, provides the franchisor the opportunity to present franchisee and company financial performance results. Currently 57% of franchisors provide a FPR which has become a competitive advantage for those franchisors who provide a detailed FPR. However, some franchisors provide a FPR but with minimum information. A study by FranchiseGrade.com entitled Franchisor Financial Transparency revealed how the most successful franchise systems had the most comprehensive FPR.
The Benefits of Providing Full Financial Disclosure
- Enables the prospect to construct a more accurate break even and cash flow analysis.
- If the franchisor provides this information to candidates it will enable the franchisor to more effectively qualify prospects. For example, how did the candidate incorporate this information into their financial models?
- A good amount of franchisee start-up problems and potential failures are caused by under estimating expenses as much as poor sales.
- When expense and cost information is not fully disclosed it’s only a matter of time before the franchisee has the correct information.
- The franchisor should provide prospective franchisees as much cost information as allowed since it can assist the candidate in their decision making.
Some franchisors fail to disclose strong financial disclosure. Disclosing this information can increase the probability that both parties make the right decision.