31 Mar Why Don’t More Franchisors Disclose Franchisee Results?
An Item 19 disclosure is an optional franchisor disclosure made in the Franchise Disclosure Document (“FDD”). It presents the financial performance of the franchisor affiliates, franchisees and company-owned units. It’s been reported that 25-40% of franchisors make a disclosure under Item 19. Based upon various discussions with industry experts I will err on the conservative side and say it’s probably around 30%.
There are numerous reasons why more franchisors don’t provide an Item 19 disclosure:
- Difficulty in obtaining consistent and credible data from the franchisees. The fear that some data is not accurate.
- Complexity of gathering, verifying and presenting the data especially on the part of large franchise systems.
- Disclosing financial data that can be viewed by competitors.
- Mixed financial results, whereby some franchisees perform poorly.
- Reluctance to project future financial performance to prospective franchisees.
- Impacting the due diligence process of prospective franchisees, whereby some could be swayed by the disclosure when making a decision to purchase the franchise.
I expect these reasons will continue to play a role in the decision not to make an Item 19 disclosure.
Franchisor benefits from an Item 19 disclosure:
- Can provide credible financial data to franchise prospects (providing it’s verified).
- Sets the franchisor apart from those franchisors that fail to make this disclosure.
- Can accelerate the franchise prospects due diligence process.
- Forces the franchisor to gather franchisee financial results and thus better monitor the network.
- Can boost the sale of new franchises.
- Can be used by the franchise prospect to conduct a more thorough financial analysis.
Despite these benefits, the fact remains that the majority of franchisors will most likely refrain from making a disclosure under Item 19. Some franchise attorneys believe that more franchisors will make a financial disclosure as they seek to sell more franchises. They may believe that an Item 19 disclosure can be an advantage to their development staff in the sale of new franchises.
There are some who feel that an Item 19 disclosure should be mandatory for franchisors based upon certain qualifying factors such as size and tenure as a franchisor. Although a case could be made for mandatory disclosure the fact remains that the requirements necessary to regulate and audit compliance would be an unlikely position for the FTC or other regulators to take. Then again, is it truly necessary? There are options that enable a franchisor to provide important financial data to prospects.
Tomorrow’s posting will explore some of these options.
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Ed Teixeira is the President of FranchiseKnowHow, LLC. He can be reached at email@example.com.