Hidden Opportunities in Financial Performance Representations

Regulators have presented franchisors with new opportunities to demonstrate their systems' strengths by permitting franchisors to make financial performance representations based on subsets of units. As a result, franchisors can use an Item 19 financial performance representation to tell their prospects about system performance over time, how the system is recovering from recent economic downturns, improvements in financial performance as a result of system changes, or even to profile the most efficient units.

As the economy begins to recover, franchisors can use an Item 19 financial performance representation to demonstrate that their systems are recovering from the recent economic downturn. If the sales figures for a system are trending up, franchisors can provide gross sales data for same-store sales from prior periods and compare them with the gross sales data for a later period. Franchisors can do so by comparing performance during the first six months of 2009 with the last six months of 2009, or comparing first quarter 2009 results with first quarter 2010 results to demonstrate an increase in gross sales. Likewise, franchisors can compare year-to-year results to demonstrate annual growth.

Franchisors can also use Item 19 financial performance representations to demonstrate the success of new business models. A franchisor can profile new model units as compared with units that operate under the older model. Franchisors who made substantial improvements or changes to their franchise systems, or who have added additional products or services, can now extrapolate just the performance results of franchisees operating under the new model, and exclude the data of franchisees operating under their older, less successful franchise models.

Franchisors can also present other measures of productivity which demonstrate an increase in the underlying metrics that drive sales. For example, a franchisor can present data showing an increase in the number of customers over a period of time and the average customer ticket. Franchisors can present data on closing rates over time demonstrating an increasing success rate in convincing customers to purchase a service. Franchisors can also demonstrate how the products and services that initially drew customers to franchisees can be used to leverage up-sells in ancillary products or services. If certain product lines are generating more growth than others, franchisors can separately disclose their various revenue streams and highlight those showing the most growth.

Franchisors need to be careful to properly disclose the material basis and underlying assumptions supporting the financial performance representation. Franchisors must state whether the data presented relates to all or only to a subset of the outlets that share a particular set of characteristics. In addition, franchisors must set forth the dates when the reported level of financial performance was achieved and the total number of units with the described characteristics, and if different, the number of units that had the described characteristics. Significantly, franchisors must disclose the number of units with the described characteristics whose actual financial performance data were used in arriving at the representation, and, of those units, the number and percentage that actually attained or surpassed the stated results.

It is also important to be clear in the Item 19 financial performance representation that the figures presented are historical figures and are not a representation of what a franchisee will do in the future. A franchisor must also clearly disclose any characteristics of the units presented that may materially differ from those being offered through the disclosure document. In short, be sure that the financial performance representation does not mislead the prospect to believe that the performance of the business is greater than it is.

By using an Item 19 financial performance representation to profile units in a way that demonstrates their successful business model, franchisors have an opportunity to differentiate themselves from their competitors.

Lane Fisher and Joseph Dunn are partners in the Philadelphia-based law firm Fisher Zucker LLC. Fisher has represented franchisors for more than 20 years, written extensively on many aspects of franchising, and is a frequent speaker on franchise issues. Dunn has practiced law for nearly 15 years and has represented franchisors in both private practice and as in-house counsel. Contact them at 215-825-3100.