Item 19 in the Franchise Disclosure Document (FDD) is where franchisors can share financial performance data to help potential franchisees make informed decisions.
This section is optional but highly useful, as it provides insights into potential earnings and business performance. Here’s what you need to know:
- What It Covers: Sales figures, income levels, gross profit margins, and net profits.
- Legal Requirements: Data must be accurate, backed by evidence, and comply with Federal Trade Commission (FTC) rules.
- State-Specific Rules: Some states require additional reviews or disclosures.
- Key Metrics Shared:
- Revenue Data (94% of franchisors disclose this)
- Operating Costs (56%)
- Profitability Metrics (53%)
- Full Profit & Loss Statements (32%)
Why It Matters:
- Helps franchisees assess potential returns.
- Builds trust through transparency.
- Protects against misleading claims.
Franchisors must ensure all claims are well-documented and updated regularly to comply with federal and state laws. This section is critical for both legal protection and fostering strong franchise relationships.
Legal Rules for Item 19
The Federal Trade Commission (FTC) has laid down specific rules to regulate financial performance representations (FPRs). These rules aim to ensure clarity, protect potential franchisees from misleading claims, and provide franchisors with clear guidelines for disclosure.
FTC Rules and Requirements
Under the FTC’s Franchise Rule, any financial performance representation must be supported by a reasonable basis. FPRs can include information about:
- Sales figures (actual or potential)
- Income levels
- Gross profit margins
- Net profits
If a franchisor opts not to provide FPRs, they are required to include the following disclaimer in Item 19 of the Franchise Disclosure Document (FDD):
“We do not make any representations about a franchisee’s future financial performance or the past financial performance of company-owned or franchised outlets. We also do not authorize our employees or representatives to make any such representations either orally or in writing…”
Additionally, various state-specific laws build upon these federal regulations.
State Laws and Regulations
In addition to federal rules, states impose their requirements, particularly regarding disclosure formats and review processes. Currently, 15 states enforce registration and disclosure requirements, with 11 states requiring state agency review and approval before franchises can be sold.
A key change took effect on January 1, 2023, when several states adopted the North American Securities Administrators Association (NASAA) Statement of Policy. This policy has influenced franchise documentation requirements in:
- Maryland
- California
- Washington
- Hawaii
- Illinois
- Minnesota
- New York
- North Dakota
- Virginia
Required Documentation
Franchisors must maintain records to back up any claims made in Item 19. While these records don’t need to be audited, they should include:
| Documentation Type | Purpose |
|---|---|
| Financial Statements | Validate revenue and profit claims |
| Tax Returns | Confirm reported income figures |
| Profit & Loss Statements | Support operational performance data |
| Unit Performance Records | Document historical results |
“Within the franchise registration states, state regulators review and evaluate financial performance representations to determine if the Item 19 disclosure conforms to federal and state requirements.”
For historical performance data, franchisors must disclose specific details such as:
- The group of outlets being measured
- The period covered
- The number of outlets included
- The percentage of outlets that achieved the stated performance
- Any unique characteristics of the measured group
Main Parts of Item 19
Item 19 financial performance representations (FPRs) are a vital component for assessing how a franchise might perform. According to the 2024 Annual Franchise Development Report, 86% of franchisors now include FPRs in their Franchise Disclosure Documents, a significant increase from just 20% in 1995. These representations help distinguish between historical performance and projections for the future.
Past Results vs. Future Estimates
Franchisors are required to separate past performance data from future projections to ensure transparency:
| Data Type | Details |
|---|---|
| Historical Performance | Includes timeframes, number of outlets, and the percentage achieving specific results |
| Future Projections | Based on economic assumptions and specific market conditions |
| Supporting Evidence | Claims must be backed by reasonable documentation, as outlined in regulations |
Types of Financial Data
The data provided in Item 19 varies widely. While most franchisors disclose revenue figures, fewer include expenses or profitability metrics. Here’s a snapshot:
| Metric Category | Disclosure Rate | Details |
|---|---|---|
| Revenue Data | 94% | Gross sales, revenue streams |
| Operating Costs | 56% | Expenses like labor, inventory, and overhead |
| Profitability | 53% | Metrics such as EBITDA and net profit margins |
| Complete P&L | 32% | Full profit-and-loss statements |
While these figures provide valuable insights, it’s important to consider how local factors may further influence franchise performance.
Location and Market Factors
The performance of a franchise can vary greatly depending on its location and market environment. Key considerations include:
- Geographic Variations: Franchises in urban areas often perform differently from those in suburban or rural locations.
- Market Competition: The level of competition and market saturation can significantly impact sales.
- Demographics: Factors like population density and the target customer base play a crucial role.
- Economic Conditions: Regional economic trends and conditions can influence profitability.
Franchisors are also required to specify whether their FPRs apply to all outlets or only certain subsets, such as those in specific locations or with similar operational characteristics. This segmentation allows prospective franchisees to better gauge how their own market might perform based on these disclosures.
Creating Item 19 Disclosures
Crafting accurate and compliant Item 19 disclosures requires a structured approach to collecting, verifying, and presenting financial data.
Gathering Financial Data
A strong Item 19 disclosure starts with reliable methods for collecting financial information. Here’s how franchisors can approach this step:
| Data Category | Collection Method | Verification Process |
|---|---|---|
| Revenue Data | POS system reports | Monthly validation |
| Operating Costs | Financial statements | Quarterly validation |
| Profitability Metrics | P&L statements | Annual audit |
| Unit Economics | Franchisee reports | Cross-checking |
Once the data is collected, it’s essential to review it thoroughly to ensure it aligns with legal and regulatory standards.
Legal Review for Compliance
A legal review is a critical step in ensuring that Item 19 disclosures comply with FTC and state regulations. This process typically includes:
- Document Review: Ensuring financial data is accurate and consistent across all reports.
- Compliance Check: Verifying that every claim aligns with FTC and state requirements.
- Final Verification: Confirming that all claims are backed by solid evidence as required by regulations.
For expert guidance, franchisors may consider consulting legal professionals, such as those at the Franchise & Business Law Group, to navigate the complexities of compliance.
Keeping Disclosures Up-to-Date
Regular updates are essential to maintain the accuracy and compliance of Item 19 disclosures. An annual update process can help franchisors stay on track:
| Timeline | Action Items | Requirements |
|---|---|---|
| Q4 | Collect data | Gather updated financial data from all units. |
| Q1 | Analyze and verify | Review and validate the new performance data. |
| Q2 | Conduct a legal review | Ensure compliance and update supporting documents. |
| Q3 | Update the FDD | Revise the Franchise Disclosure Document and distribute it. |
Franchisors should also be prepared to make immediate updates if there are significant changes in operations or market conditions. This ensures transparency and ongoing compliance with regulatory standards.
Effects on Franchise Relations
Item 19 disclosures play a significant role in shaping the relationship between franchisors and franchisees. When these disclosures are compliant and well-structured, their influence on franchise dynamics becomes clearer.
Franchise Investment Choices
For example, Right at Home reported an average annual net billing of $1,739,357.34 for offices operating for at least one year. Interestingly, 34% of its 361 offices met or exceeded this benchmark.
When evaluating franchise opportunities, investors often weigh several factors:
| Investment Factor | Key Considerations | Impact on Decision |
|---|---|---|
| Market Fit | Location-specific data | Helps assess performance in similar markets. |
| Performance Trends | Year-over-year metrics | Offers insights into system stability. |
| Unit Economics | Segmented data by size/type | Aligns with the investor’s financial capacity. |
| Performance History | Time-based performance analysis | Highlights growth trajectories. |
These considerations provide a framework for understanding the potential risks and rewards associated with a franchise investment.
Legal Risks and Protection
To reduce legal risks, franchisors must ensure their documentation is thorough and up-to-date. Consistency in messaging, regular updates to reflect market changes, and strict adherence to compliance protocols are essential.
But compliance isn’t just about avoiding legal pitfalls – it also plays a role in marketing. Leveraging financial data effectively can strengthen a brand’s appeal.
Sales and Marketing Uses
Transparency in financial metrics fosters trust between franchisors and franchisees. As U.S. Lawns Franchise explains:
“A relationship between a franchisor and franchisee based on trust and transparency leads to better communication and less surprises, and we believe that including Item 19 in the FDD is a first step in the right direction.”
Franchise brokers also tend to favor brands that provide detailed financial performance data. This preference impacts several aspects of marketing and sales:
| Marketing Aspect | Best Practice | Business Impact |
|---|---|---|
| Data Presentation | Verified metrics with clear communication | Builds credibility and attracts higher-quality leads. |
| Market Positioning | Consistent and transparent disclosures | Improves perception and leads quality. |
| Sales Process | Uniform financial data | Speeds up decision-making for prospects. |
| Broker Relations | Comprehensive financial performance data | Increases referral rates. |
This level of transparency benefits both franchisors and franchisees. It equips franchisees with the information they need to make informed decisions, while also contributing to stronger overall system performance.
Summary
As outlined earlier, Item 19 plays a crucial role in sharing financial performance data with potential franchisees. With the majority of franchisors now including these disclosures, its significance continues to grow in franchise development.
The importance of Item 19 can be seen across three key areas: legal protection, investment decisions, and system growth.
| Dimension | Impact | Key Consideration |
|---|---|---|
| Legal Protection | Protects against misrepresentation claims | Requires thorough documentation and a solid basis for claims |
| Investment Decisions | Supports data-driven evaluations | Must include historical financial data and clear assumptions |
| System Growth | Boosts franchise sales | Builds trust through transparent communication |
These aspects highlight how Item 19 serves both regulatory compliance and practical business needs, ensuring franchisors and franchisees benefit from detailed financial disclosures.
When it comes to financial performance representations, franchisors must strictly comply with federal and state franchise laws. Typically, these disclosures focus on:
- Gross sales figures
- Cost of goods sold
- Gross profit margins
- Key performance indicators (KPIs)
- Customer-related metrics
The importance of accuracy in these disclosures cannot be overstated:
“The Item 19 is one of the most critical and most litigated elements of a franchise agreement. It is extremely important that you not only take your time to carefully craft your Item 19, but also that you have legal guidance in finalizing this portion of your FDD.” – FMS Franchise
For franchisors who choose not to include financial performance representations under Item 19, there is still an option to share actual operating results for specific franchise locations that are up for sale.
Franchise brokers place a high value on well-prepared financial performance representations. These disclosures foster transparency and trust, enabling smarter investment decisions and laying the groundwork for steady system growth.
FAQs
Why should franchisors include Item 19 disclosures in their Franchise Disclosure Document (FDD)?
Including Item 19 disclosures in the Franchise Disclosure Document (FDD) plays a key role in building transparency and trust between franchisors and potential franchisees. This section contains detailed financial performance data, giving prospective franchisees a clearer picture of the potential profitability of the franchise. With this information, they can make more informed investment decisions.
For franchisors, including these disclosures boosts credibility and demonstrates compliance with federal and state regulations. It also helps minimize the chances of legal disputes or misunderstandings down the road. Beyond compliance, sharing financial performance data can differentiate a franchise in a competitive market, highlighting its financial strength and growth opportunities. While not legally required, adding an Item 19 disclosure is a strategic move that benefits both parties.
How do state laws influence the financial performance representations in Item 19 of the FDD?
State laws significantly influence the financial performance representations (FPRs) outlined in Item 19 of the Franchise Disclosure Document (FDD). While federal guidelines establish a foundational framework, individual states often add their requirements. For example, some states mandate that FPRs be supported by verifiable historical data, while others may limit the types of earnings claims franchisors are allowed to include.
Additionally, franchisors must navigate state-specific registration and disclosure rules, which can impact how financial details are shared with prospective franchisees. These regulations are designed to promote transparency and safeguard franchisees by ensuring that all financial claims are accurate and well-documented. For franchisors operating across multiple states, understanding and following these laws is not just important – it’s essential.
What should franchisors do to ensure their Item 19 disclosures comply with FTC regulations?
Preparing Item 19 Disclosures for FTC Compliance
Franchisors need to approach their Item 19 disclosures with care to align with FTC regulations. A key step is specifying whether financial performance representations (FPRs) are based on past results or future projections. Any claims made must be backed by reliable, verifiable data – unsupported or misleading earnings statements can lead to serious legal trouble.
It’s equally important to keep thorough records that can validate the financial details shared. Franchisors should also be clear about the source of the data, whether it comes from franchise units or company-owned locations. These practices not only ensure compliance but also help build trust with potential franchisees, laying the groundwork for strong, successful partnerships.