Making Sense Out Of Earnings Claims

For anyone thinking of buying a franchise business, one of the first thoughts that come to mind is “How much can I make as a franchisee?”

Fortunately, there has been a growing trend to tell candidates more about the earning potential of a franchise and that’s done in the Item 19 section of the Franchise Disclosure Document (FDD). Some franchisors consider it a marketing plus to provide earnings claims (now called financial performance representations or FPR’s) while others consider it a legal liability even if they have good numbers to report. So where one brand provides extensive information another may skip over Item 19 altogether.

The FTC rules do not require earnings claims nor do they prohibit a franchisor from providing them. But they do spell out very specifically how this information can be communicated to interested prospects. One of those specifics, oddly enough, is that whatever information is provided it must be as accurate and representative as possible with any qualifications or assumptions clearly labeled. Given the broad range of earnings experiences within large franchise systems, gathering and providing information under these rules can be challenging and expensive. So some franchisors choose to avoid the issue rather than risk having their data challenged should a complaint end up with the FTC.

So let’s focus on what you can do to gather meaningful earnings information about franchises you are considering investing into.

First of all, when FPR’s are presented in Item 19 be sure the measures reported are meaningful and would apply in your particular investment scenario. If, for instance, a franchisor provides average gross sales numbers for units open 2 years or more and all of their stores from that period opened in Gulf Coast states, then the data won’t be particularly useful if you’re considering opening in New England.

Whether or not a franchisor provides earnings claims your best source of information will be to talk to existing franchisees. And while you can’t exactly hit them with “How much money did you make last year,” if you approach the question thoughtfully you’ll be able to arrive at that answer by the end of the call.

Start the call by showing genuine interest in learning more about their franchise and how it operates. Ask questions about the quality of training received, what the marketing support consists of and how close to original forecasts their sales and profits are to date. Then move on to questions about sales and expenses and how they compare to forecasts. If you do good planning for the calls and keep good notes you should be able to gather enough data in the course of a dozen conversations to provide percentages to use in your own forecasts.

Of course, be sure to make enough calls for the data to be valid. In particular, focus on locations that have characteristics similar to the one(s) you’ll be dealing with. Be sure to call franchisees in all performance ranges from high to low and even a few who left the business. If you find you didn’t get enough names initially, ask the franchisor for more.

Finally, there are some rules of thumb that apply to franchise earnings. A good return on passive investments – stock, bonds, real estate, etc., is typically 10 to 15 percent over time. But with a franchise you’re investing both money and your time so the return should be higher to offset the additional risk. Look for returns of 25-30% on your initial investment on an annual basis and you should be able to reach that level by your third year in business.