Carefully Evaluate Promise of Earnings
The main appeal of operating a franchise for most people is the promise of earnings that comes with being a part of an established brand. Prospective franchisees will be eager to see the promise of earnings or other representations about a franchise’s finances. However, having a careful approach when evaluating earning promises can help you maintain a realistic perspective about the investment potential of a franchise opportunity.
Clarify Assumptions or Gaps in Data Used in Promise of Earnings
Item 19 of an FDD is where a franchisor may include any promise of earnings or other financial performance representations (FPR). However, if a franchisor chooses to make a claim about potential earnings, the claim must have a reasonable basis to support it. Additionally, the claim must include:
- The source and limits of the supporting data
- Assumptions used to make the claim
A claim of a promise of earnings may rely on limited amounts of data. For example, the earnings data (e.g., gross sales, profit, etc.) may only be available from a select amount of franchises. The data could also be from a different geographic territory than your franchise opportunity or could involve a territory with different socio-economic demographics. Finally, the FPR may operate under assumptions about sales figures or other operation specifics.
Consider the Relevance or Value of the Financial Metric Offered
The nature of a promise of earnings for FPR can greatly vary from franchise to franchise, and it’s possible a franchisor will attempt to offer metrics that paint the opportunity in the best light possible. However, franchisees should fully consider the relevance or value of a promise of earnings to set realistic expectations about the potential investment. Some standard FPRs may incorporate the following types of figures.
Income Average
An income average can be a somewhat misleading figure without proper context. Relevant to evaluating the value of an income average might be information about the participating franchises (and any excluded franchises). Furthermore, seeing the data from each franchise that creates the average may help you identify the range of potential averages and determine if the numbers from one location significantly boosted the size of the average.
Gross Sales
An FPR may provide data about the gross sales you could expect from owning a franchise. The downside to relying heavily on information about gross sales is that it may not provide much indication about what your potential profit could be. That’s because gross sales figures don’t consider the expenses that you must subtract from the sales figures to determine net profits.
Net Profits
Like income averages, data about net profits may not use complete or relevant information. For example, the net profits figures might only include select franchises. Another important point of distinction is whether the net profits data are from franchisor-owned locations. A franchisor-owned location will generally have lower costs (e.g., less training requirements, no large capital expenses, and no lease payments because they own the land).
Legal Representation When Starting or Joining a Franchise
Careful consideration of a promise of earnings or other franchise disclosures can help prospective franchisees make better decisions about their fit within a franchise opportunity. Obtaining attorney representation during the vetting process may provide a greater understanding of certain disclosures in an FDD before signing a franchise agreement.
Have questions about promise of earnings or other FPRs? Contact Franchise & Business Law Group today for a consultation.