This lesson is part of our free Franchise 101 course.
The most important data you can look at when considering a franchise is its finances. Franchises have to present information on this as part of their annual Franchise Disclosure Document (FDD), and this can be incredibly valuable. However, it’s not always consistent, so you need to know how to make the most of it.
What Is Item 19?
The FDD is a document that franchisors have to produce every year, providing potential franchisees with information about their business. Among the details they have to include is Item 19, financial performance representations.
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Item 19 contains financial performance data. There’s one clear rule around this data, which is that franchisors aren’t allowed to make any representations directly to prospective franchisees that aren’t stated in Item 19. In other words, if they want to use financial data to attract franchisees, that data has to be included here.
The Problem with Item 19
Unfortunately, that’s the only really clear rule. Franchisors have considerable leeway in deciding what to report in Item 19 and there’s no standard format for the information. Some franchisors provide a lot of detailed information about revenues, expenses, and even operating income, while others provide less information.
It’s worth remembering that everything the company wants to tell potential franchisees about its finances is included here. That means that this is the company’s sales pitch. If they’re leaving something out, there’s probably a reason: do they think that figure is bad, or just irrelevant to their case?
This can make it hard to compare franchises. How do you know which one is best when one of them has produced two key figures, both of which look great, while another has provided a whole range of variable data? Do you go for the attractive prospect or the one you know more about?
Making the Most of Item 19
One way to fill the gaps is to look at similar franchises. Competing franchises within the same industry often have very similar unit economics, so you can fill in gaps around expenses and profits from competitors’ reports. Comparison with competitors can also give you an idea of whether a figure really is good in relative terms, or whether it just looks impressive when standing on its own.
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Remember to think about what a franchisor isn’t telling you and why that might be. It won’t always be to hide uncomfortable figures, but if critical data is missing, you should at least be wondering why.
It’s also worth taking the time to read and watch commentary on FDDs and Item 19 in particular. Franchising experts with years of experience take the time to dig into the details, providing context and comparisons, and these can add to your understanding.
Item 19 is a valuable source of information for potential franchisees. Learning to understand its data and to put that in context is critical in picking the perfect franchise for you.