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How Much Money is that Franchise Going to Make?

January 12, 2014

‘How much money can I make?’.  That seems like a fair enough question for a franchisee to ask of a franchisor.  After all, the franchisee will be paying a healthy premium for the right to do business under the franchisor’s trade-mark, so it’s reasonable to wonder what the return on that investment might be.  Surely franchisors know the answer, right?  Certainly, they have years of sales reports on franchisees to offer some sort of projection for new franchisees, don’t they?

Well, not so fast, prospective franchisee.  Despite the fairness and reasonableness of your query, earnings claims are not only figures that franchisors are not required by law to disclose, but the provision of this information may, in fact, expose franchisors to tremendous potential liability.

Let me go on the record as saying that, where it is practical to do so, I fully support the provision of a franchisor’s financial performance representations to prospective franchisees in the franchise disclosure document (the disclosure document is a prospectus-like document which franchisors are required to provide to franchisee candidates in certain provinces before they agree to become franchisees).  I believe that organized franchisors have verifiable data that is available and has the potential to be material in a franchisee’s investment decision.  In addition, financial disclosure of this nature may assist a franchisee’s bank with approving a loan.

But there are definitely times when the disclosure of earnings claims is not appropriate, such as where a first-time franchisor provides sales information for its corporate locations because that’s all of the information that is available – this may be less than helpful for a franchisee since their sales won’t necessarily parallel the experience of the established franchisor.  Likewise, a franchisor with units in Saskatchewan only, for example, may wish to think twice before disclosing to its first Toronto prospect how much money can be made, given the considerable disparities between those markets.

There are also franchisors who are quite simply not organized to keep good enough records of franchisee performance that a prospective franchisee can rely on that financial information.

And franchisees should always be sceptical of earnings claims that are a bit too selective with respect to the number of years of sales or specific locations’ performance that is disclosed – if a franchisor has 20 units, and discloses the results of three seemingly random but profitable ones during a short time period, they might be hiding something about the performance of the balance of their franchise system.

Which is exactly why franchisors (both good and bad) may be reluctant to provide financial performance information.  Whether the information is accurate and organized or not, by making the disclosure in the first place, franchisors open up the possibility that underperforming franchisees receiving that information may later allege that they were misrepresented, if they never achieved sales at that level.

For this reason, it is critical that franchisors draft (and franchisees be aware of) proper disclaimer language that sets out exactly what the criteria were for assembling these projections, and fully describes the reasonable bases for any assumptions which inform that disclosure.  A projection is exactly that – a projection.  It is not a statement of fact, and any good franchisor would never promise a franchisee that they will, without exception, generate a certain minimum amount of revenue.

It is also why franchisors should think long and hard about whether they have financial claims that are worth disclosing after all of the qualifiers are inserted, and why prospective franchisees should not view a disclosure document void of financial claims as incomplete.

Tags: Franchising