With increasing frequency, franchisors are including an Item 19 Financial Performance Representation in their Franchise Disclosure Documents [FDD].
A Financial Performance Representation is defined under the Federal Franchise Disclosure law as:
Any oral written, or visual representation, to a prospective franchisee including a representation in general media, that states, expressly or by implication, a specific level or range of actual or potential sales, income, gross profits, or net profits. The term includes a chart, table, or mathematical calculation that show possible results based on a combination of variables.
Under the Federal Franchise Disclosure law, the making of a Financial Performance Representation is optional. Franchisors can but are not required to make a Financial Performance Representation. Whichever way franchisors choose, they must include prescribed disclosure language.
If a franchisor chooses not to include an Item 19 Financial Performance Representation [FPR] in the FDD, the franchisor cannot discuss the earnings, profits, or sales of potential franchises.
The Federal franchise disclosure law categorizes permitted Financial Performance representations into 2 groups:
• Historic Financial Performance Representations
• Forecast of Future Financial Representations
For both categories of Financial Performance Representation, the franchisor must have a:
1. Reasonable basis; and
2. Written substantiation for the representation.
After the basic reasonableness and substantiation requirements, the disclosure requirements for historic and future Financial Performance Representations diverge.
Historic Financial Performance Representations must articulate which, when, and how many franchise outlets were used to make the representation in very regulatory explicit terms. Future Financial Performance Representations must layout assumptions, factors, and conditions related to numerous components of the representation.
Historic Performance Representations are more common than Future Financial Performance Representations. Often times Franchisors may simply use franchisee sales reports as the basis for Historic Performance Representations. However, if the franchise system is new and not sufficient samplings of the franchises are reporting to make a reasonable Financial Performance Representation, franchisors may consider a Future Performance Representation.
The reasonable basis for the claims is one of the biggest liability concerns related to Financial Performance Representations. Franchisees and state examiners may challenge the reasonable base of representation, if the representation among other things is:
• Based on too few franchisee outlets
• Based on corporate outlet with differing operating costs
• The date of the representation is too removed from the issuance/effective date of the disclosure document
• The characteristic of the outlets used for the representation differ significantly from the franchise opportunity being offered by the franchise disclosure document