If you’re interested in buying a franchise and in the process of reviewing the franchise disclosure document (FDD), I recommend a post from business attorney and franchise consultant Mike Sheehan on Item 19 financial disclosures. Mike starts his post by giving some good general information about FDDs including the fact, despite the voluminous nature of the document, it is not everything you need to know about the franchise and its operations. Rather, the FDD is really just the starting point and the most useful information contained in the FDD is the list of franchisees and former franchisees that should you should interview about the franchise.
Item 19 of the FDD is the section that covers financial performance representations. There are several things to keep in mind when reviewing Item 19 of the FDD. First, understand that franchisors are not required to provide financial performance representations. In fact, most franchisors do not provide this information in their FDD. Why? As Sheehan points out, this could be for a variety of reasons including the fact the franchisor does not have reliable information or perhaps the financial representations do not paint a pretty picture. If the franchisor chooses not to provide financial performance representations, it’s an important part of your due diligence to understand why.
If past financial performance representations are made by the franchisor, it’s imperative to understand the limitations of these disclosures. Sheehan cites as an example that it may not do you much good to have financial performance representations from just Florida franchisees if you are seeking to purchase a franchise in North Dakota. The results could be dramatically different in those regions. Additionally, there is no obligation that the financial representations are based upon generally accepted accounting principles (GAAP). This makes comparisons potentially difficult. Moreover, any future forecasts or projections are really just guesses.
Overall though, I’d like to see Item 19 financial performance representations in the FDD. But understanding what the numbers show is a must for anyone conducting due diligence of a franchise.