Everybody's Doing It

Six benefits of disclosing earning claims

Performing a financial analysis of your existing units, for disclosure to franchise candidates in Item 19 of your FDD, could be one of the most important decisions you make for your concept.

Franchise candidates are becoming more educated about the franchise investigation process, thanks to the Internet and to broker networks exposing them to more solid franchise concepts.

Also, during this presidential election year, and with all the "talking heads" on TV instilling fear of a recession, franchise candidates will be looking more carefully for financially solid concepts that can validate an earnings potential a new entrepreneur can live with. Further, since financing has tightened up, potential franchisees will need a solid business plan to submit to financing sources.

With that level of exposure, I believe for the first time more and more candidates expect the Item 19 to say something besides "We've decided not to disclose this information. We would rather have you validate income and expenses by talking with our existing owners." However, disclosing this information in Item 19 of your FDD had definite benefits for both franchisor and candidate.

1) It's what everyone wants to know. The number-one question a franchise sales consultant gets is: "How much money can I make?" Early in the process, this is the most daunting question franchise sales people field. It's awkward when your candidate is working with other concepts that have a claim and you don't! In the candidate's mind it feels evasive. Why wouldn't you make the claim? Providing Item 19 information in your FDD also can help protect you against lawsuits by keeping your salespeople from doing the "income claim dance."

2) Improves the relationship with the candidate. If you've decided to make an earnings claim, your franchise sales team will be able to create a better relationship with potential franchisees by being in a position to share the Item 19 information at the appropriate time.

3) Improves the validation process. Item 19 information does not take the place of candidates making validation calls to existing franchisees. To the contrary, you should encourage them to ask franchisees how their experience matches up with the Item 19 financial information you have provided.

4) Evens the playing field. An increasing number of franchisors have started using earnings claims (now called FPRs) because more franchisors are using broker and referral networks that require franchisors in their inventory to disclose figures in Item 19. Whether you are using broker networks or not, you will still be selling against an increasing number of franchisors that provide Item 19 information.

5) More information for the lenders. If your franchise requires a third-party lender to finance the opportunity, the earnings claim will assist the candidate in building a business plan to submit to the lender. Today it seems that an increasing number of candidates want to know they can get financed before they sign agreements. Because of this, a franchisor with an earnings claim (FPR) can assist the candidate in securing financing prior to the signing of agreement.

6) More protection for the franchisor. Deciding to use an earnings claim will create many questions. This exercise should involve many of your team members as well as a competent law firm. If you look at the "earnings claim" (FPR) as just a sales tool to sell more franchises that may be the wrong reason. If it becomes a tool for candidates that assists during the due diligence process and helps create questions for validating with existing franchisees, now you're on the right track.

What to tell?

What type of earnings claim should you make? Gross sales? Major expense line numbers? Unit sales more than one year old? The entire franchise system? Company-owned units?
Once you've decided what type of information to disclose, the work begins. Gathering "good" information to provide for Item 19 is very important. It must be verifiable but also portray a realistic picture of the franchisee's potential. A bad example would be to use your company-owned units but their territory is five times the size of what a normal franchise would be granted.

Making the most of it

How can you best use this information in the qualification process? Simply because you have an earnings claim does not give you the liberty to just throw this information out to a candidate. The earnings claim's main purpose is to protect the franchisor and to assist the candidate in the research process.

You first need to engage your candidate in the process. Get to know the candidate and find out why they want a business now. Second, I would do a program review to highlight the inter-workings of the franchise concept. The next step would be to get the application and then to send them the FDD. When reviewing the FDD with the candidate, highlight the areas of interest and go through each item to explain how and why the document is used in the process.

When you get to Item 19, you need to present the earnings claim correctly. Most will have a couple of paragraphs (or pages) of disclaimers regarding how the FPR has been developed. You should understand how your earnings claim has been established so there is no misunderstanding.

For example, it is not legal to go beyond the disclosed information. If you put together a "gross sale" Item 19 without any expense information, this means you can talk only about the gross sales in the FDD; it does not allow you to create expenses or even to talk about other gross sales outside the Item 19 information.

Item 19 disclosure is the wave of the future and, quite frankly, a great service for prospective franchisees. I know that any company we will be consulting with in the future that provides good item 19 information will have a "strong" recommendation from me.