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Hidden Ways Franchisors Can Manipulate Item 19

Published on March 30, 2018

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At the current time 60% of franchisors provide a financial performance representation (“FPR”) under Item 19 in their Franchise Disclosure Document. As the disclosure of an FPR becomes more prevalent so too does the quality of the financial information become more important. Franchisors that provide more accurate and detailed FPR’s will be providing valuable and practical information to prospective franchisees. Providing more financial disclosure will be a valuable edge for a franchisor. However, some franchisors will provide information in their Item 19 that can be misleading and confusing to franchise candidates.

Some franchisors use what is known a “negative disclosure” in Item 19 concerning the provision of information about the sales or profits at existing franchises, specifically saying “we do not make any representations about a franchisee’s future financial performance or past financial performance of company-owned or franchised outlets.” One franchisor provided information, including financial projections, which was laden with false data.” This practice means that the franchisor provided a financial performance representation (“FPR”) outside of its FDD, in violation of federal and state franchise sales laws.

The NASAA Franchise Project Group learned that some franchisors were furnishing financial performance representations featuring only the top 10, or top 10 percent, highest performing outlets. Others were disclosing company-owned unit net profit numbers but omitting the key fact that these company-owned units paid no royalties and had many of their expenses paid by their corporate parents. Yet other franchisors would feature company-owned unit average “gross sales only” financial performance representations without disclosing that average franchised unit gross sales numbers were substantially lower. Under both the FTC Franchise Rule and state franchise laws and regulations, such financial performance representations were technically permissible—but were viewed by the regulatory community as deceptive.

As a result, NASAA formed a committee in 2014 to address the issue of financial performance representations and what new requirements, restrictions and prohibitions, if any, should be imposed upon franchisors.

NASAA released its first iteration of the proposed Commentary for public comment in October 2013; modified it after receiving extensive public input; released it for a second round of public comment in September 2016; and, after effecting minor modifications to the Commentary in response to said additional comments, submitted the revised final 2017 NASAA FPR Commentary to the full NASAA Board for approval which, as noted, took place in May 2017.

How the FTC Franchise Rule and State Franchise Laws Define “Financial Performance Representation”
“Any representation, including any oral, written or visual representation, to a prospective franchisee, including a representation in the general media, that states, expressly or by implication, a level or a range of actual or potential sales, income, gross profits, or net profits. The term includes a chart, table, or mathematical calculation that shows possible results based on a combination of variables.” Simply stated, franchisors that provide a FPR must adhere to the FTC Franchise Rule and any deviations from their definition will represent a violation of that rule.

Prospective franchisees that are considering a franchise with a FPR are advised to obtain advice from a qualified franchise attorney, lest the candidate gets deceived by false information.

About the Author: Ed Teixeira
Ed Teixeira is a recognized franchise expert with over 40 years’ experience in the franchise industry. He has served as a corporate executive for franchise firms in the retail, manufacturing, healthcare and technology industries and was a franchisee of a multi-million-dollar home healthcare franchise. Ed and Richard Chan are the authors of a new textbook, Franchising Strategies: The Entrepreneurs Guide to Success, to be published on July 1st by Routledge on July 1st. He has participated in the CEO Magazine Roundtable Meetings with business leaders from around the country and has spoken at a number of venues including the International Franchise Expo and Chinese Franchise Association in Shanghai, China. Over the course of his career, Ed has been involved with over 1,000 franchise locations and launched franchise concepts from existing business models. Ed can be contacted at [email protected].

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