Understanding Item 19 – Financial Performance Representations
The question that usually determines the final signing on the line for a franchise is the answer to “How much money can I make?
” In the 1970s the Uniform Franchise Offering Circular introduced the infamous Item 19 on the Franchise Disclosure Document. Item 19 in the Franchise Disclosure Document (FDD) is the section that provides details on earnings, costs, and other factors likely to affect future financial performance after a candidate signs on to become a franchisee.
What it is
Item 19 is industry specific, so franchisors can put in what they want as long as they follow the guidelines. For example, restaurants might share an average food and labor cost percentage or average gross sales. To put it plainly franchisors can include information showing how existing franchise units are performing and/or projections for future performance.
Read our article “How Much Money Can I Make as a Franchisee?” to learn how to best digest the information in Item 19.
What to look for
The more information a franchisor shares, the better. That simply means a greater opportunity for financial planning on the franchisee’s part and more transparency between franchisor and potential franchisee. For restaurants pay extra attention to gross sales versus the percent of food and labor costs. Do the numbers make sense? Do they add up?
The legality of it all
You can take a breather: franchisors are legally not allowed to include anything in Item 19 that is a false representation or unsubstantiated. They must explain their reasoning and underlying assumptions. There are a lot of legal sanctions buffering you against false Item 19s. But better safe than sorry: ask existing franchisees how their sales are and how their restaurant performed. This will also give you a chance to learn more about the business.
What if there isn’t an Item 19?
Franchisors do not have to include an Item 19 on their FDD. In fact only about 30% of franchisors include the financial snapshot.
This could be an indicator of a few things. Sometimes it means that they have numbers that they do not wish to share, as they might not be as lucrative or positive as a potential franchisee could be looking for. It could also mean the franchise is too new to have any financial representation to detail.
Another possibility is that their franchising structure is set up so a franchisee gives a monthly flat fee, so the franchisor does not gather enough information to disclose a proper financial representation report. These are just a few reasons why franchisors will not include financial representations.
All in all Item 19 is a crucial part of any franchise sale. Look over your numbers carefully and hire a lawyer and accountant to help you out. Be sure to ask your questions, and if you need more guidance on the financing side, read our article “How Much Money Can I Make as a Franchisee?”
or “9 Common Questions About Financing a Franchise Purchase.”
*This blog is in no way to be taken as legal advice.