Financial Disclosure is More Than an Item 19

Published on February 05, 2017

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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.

    Download our exclusive report on Financial Transparency here.


About the Author: Ed Teixeira
Ed Teixeira is a recognized franchise expert with over 35 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 is the author of Franchising From the Inside Out and The Franchise Buyers Manual. He has participated in the CEO Magazine Roundtable Meetings with business leaders from around the country and spoke at a number of venues including the International Franchise Expo and the 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 631-246-5782 or ed.teixeira@franchisegrade.com.
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