Why Financial Transparency Matters in Franchising
Before investing in a franchise, it’s essential to understand what Item 19 in franchising is and how it impacts your financial decision. Item 19 of the Franchise Disclosure Document (FDD) provides crucial financial performance representations (FPRs) that help you evaluate a franchise’s profitability and long-term success. This section helps prospective franchisees set realistic expectations, compare opportunities, and avoid misleading financial claims.
In this guide, we will break down what Item 19 includes, how to interpret financial data, and what to watch out for when evaluating financial performance representations.
What is Item 19? Breaking Down Financial Performance Representation
The Role of Item 19 in the FDD
Item 19 is the section of the FDD where franchisors may disclose financial performance data about their existing franchise locations. This can include:
- Gross revenue from existing franchisees
- Net profits or EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)
- Sales growth trends
- Break-even timelines
Are Franchisors Required to Provide Item 19?
No. The Federal Trade Commission (FTC) does not require franchisors to provide financial performance data. However, if a franchisor chooses to share earnings claims, they must be disclosed in Item 19 of the FDD.
Approximately 60 percent of franchisors include Item 19, while the remaining 40 percent do not disclose financial performance at all. If a franchisor omits this section, it raises questions about why they are unwilling to share performance data.
How to Analyze Financial Performance Data in Item 19
Not all Item 19 disclosures are the same. Some franchisors provide detailed financial data, while others only offer limited earnings figures. Here is how to analyze Item 19 properly
Review the Sample Size and Relevance
- Check how many franchise locations are included in the financial report.
- Ask whether the data represents only company-owned locations or franchisee-owned units.
- Ensure the sample size is large enough to reflect overall system performance. Keep in mind, you will still have the opportunity to speak with owners in each brand and get additional information from them regarding earnings.
Look at Averages vs. Medians
- Averages can be misleading if some top-performing locations skew the data.
- Median figures show a more balanced representation of franchise performance.
Consider Geographic and Market Differences
- A franchise in New York City may have higher revenue than one in a rural area.
- Ensure that the earnings data reflects locations similar to where you plan to operate.
Understand Expense and Profit Assumptions
- Check whether net profit figures include all operational costs, such as rent, payroll, marketing, and inventory.
- Ask whether financial projections assume high-volume sales that may not be realistic.
Common Red Flags in Financial Performance Representations
Not all Item 19 reports are transparent. Some franchisors manipulate data to make their opportunity look more attractive. Watch out for these warning signs:
Selective Data Presentation
If the franchisor only includes top-performing franchisees in the report, the numbers may not be realistic.
No Clear Definition of Key Financial Terms
- Ensure the franchisor defines what is included in gross revenue, EBITDA, and net income.
- Ask whether royalties and marketing fees have been deducted from profit figures.
Unverified Financial Claims
- Be cautious if a franchisor provides verbal earnings estimates but does not include them in Item 19.
- If earnings claims are not backed by data, they could be exaggerated.
- It is not permitted legally to be speaking about unpublished earnings claims, if the franchisor is doing this that is a major red flag.
Absence of Item 19
- If a franchisor chooses not to include Item 19, it does not automatically mean the business is unprofitable.
- However, it does mean you will need to gather financial data from existing franchisees and independent research.
What to Do if a Franchisor Does Not Include Item 19
If a franchisor does not provide financial performance representations, you can:
Speak with Current Franchisees
- Ask how long it took them to break even.
- Get insights into monthly expenses and real profitability.
Conduct Independent Market Research
- Analyze the industry growth trends for the franchise’s sector.
- Research competitor franchises to compare potential earnings.
Work with a Franchise Consultant
- A franchise consultant can help you interpret financials and avoid misleading claims.
- At Paradigm Franchising, we provide free consultations to help investors navigate franchise finances.
Using Financial Data to Make a Smart Investment
Understanding Item 19 is a crucial step in evaluating a franchise opportunity. By carefully analyzing earnings claims, expenses, and financial assumptions, you can:
- Identify profitable franchise opportunities
- Avoid misleading financial projections
- Make an informed investment decision
Making a well-informed franchise investment starts with understanding the numbers. By evaluating FDD financials and knowing what to look for in Item 19, you can set realistic expectations and choose a franchise that aligns with your financial goals.
At Paradigm Franchising, we provide expert guidance to help you assess franchise opportunities with clarity and confidence. If you're ready to explore your options, connect with us today, and let’s take the next step in finding the right franchise for you.