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Evaluating a promise of earnings

| Jun 19, 2020 | Firm News, Franchise Law

Investors who buy a franchise should be wary of a franchisor’s guarantee of making a large amount of money quickly. Nonetheless, the franchisor may disclose information about potential sales and income known as an earnings claim or financial performance representation (FPR).  The FPR, if made, must be included in Item 19 of the Franchise Disclosure Document (FDD).

Those that provide an FPR disclosure are required by law to offer a reasonable basis for their claim. This should include:

  • Disclosing the source and limitations of the claims and data
  • Disclosing critical assumptions involving the claim

The franchisor should not veer from the Item 19 disclosure in the FDD by providing any information that is separate or different than that disclosure. The franchisee can then go over the numbers with an accountant and attorney to determine if the claims are reasonable and applicable to the scale and type of business the franchisee plans to run.

Other issues in evaluating potential earnings

The Federal Trade Commission also recommends evaluating these other matters to understand a franchise’s earning and income potential:

  • Typical claim: Ask whether the claim and data are characteristic of all franchises and how many franchisees were used to get that data.
  • Income average: Be sure to determine that the numbers provided are an average versus a specific success story outside the norm.
  • Gross sales: These numbers may not be as helpful because they do not factor in expenses, like overhead and rent.
  • Net profits: Find out if the information is coming from a franchisor-owned outlet (these typically have lower operating costs). They may also own rather than lease their property.
  • Geographic relevance: The buyer should make sure that any comparable examples given by the seller are similar to the locations considered by the buyer, for example, urban, suburban or rural
  • Context: Franchisors have different backgrounds with some more experienced or educated than others.
  • Earnings claims: The franchisor might ask the franchisee to sign a statement (sometimes done as an interview or questionnaire) asking whether any earnings guarantees were made. Report any earnings information the franchisor provides so that there is protection if the franchisee later wants to contest the agreement.
  • Speak to existing franchisees: Existing franchisees are your best resource for learning whether the earnings claims made by the franchisor are accurate and reflect what the franchisees have experienced.

Legal guidance offers peace of mind

An attorney should review any contract that involves substantial amounts of money, and ones involving the purchase of a franchise and earnings potential are no different. Potential franchisees can work with an attorney experienced in handling these types of agreements to ensure that the franchisor’s disclosures are compliant with federal and relevant state laws. This can provide peace of mind when making the final decision to invest in a franchise opportunity