DEFINITION OF A FRANCHISE EARNINGS CLAIM
What is a franchise earnings claim? As a prospective franchisee, you want to know how much money you can expect to generate from the franchise business in which you are investing. A franchise earnings claim is any information provided to a prospective franchisee that allows that individual to predict the earnings or revenue that he/she can generate from the franchise business.
IS IT LEGAL TO PROVIDE A FRANCHISE EARNINGS CLAIM?
The only way that a franchisor can provide an earnings claim to a prospective franchisee is through Item 19 of the Franchise Disclosure Document (FDD). Item 19, Financial Performance Representations, is the only legal method for a franchisor to make a franchise earnings claim showing the revenues of its corporate and/or franchise businesses. A sales representative, consultant or broker cannot legally provide any franchise earnings claim that is different than what is in the Item 19 of the FDD for that franchise system. The safest response for any franchisor, sales rep, consultant or broker is to let the prospective franchisee know to look at Item 19 of the FDD he/she was given.
IS IT LEGAL TO SAY ANYTHING ELSE?
When the question is asked by a candidate, there is always the temptation by the franchisor, sales rep, consultant or broker, to want to provide answers. However, whether the franchisor, sales rep, consultant or broker whispers a response, scribbles it on a piece of paper that is later destroyed, or responds in any other fashion except referring to the Item 19 disclosure, the entire sale is jeopardized. A prospective franchisee can ask for rescission or sue for fraud if there is a disclosure that is different than what is in Item 19 of the FDD. The prospective franchisee wants to rely on some numbers, however, even the Item 19 disclosure is historical and not based on what that individual will do in revenues. Each franchisee markets and sells differently. Success of the franchise is often determined by location, motivation of the franchisee, franchisee’s skills in marketing and selling, the product or service, etc. Historical data can only tell a prospective franchisee limited information.
WHAT KIND OF RESEARCH SHOULD BE DONE?
A prospective franchisee must do his or her homework before investing in a franchise opportunity. He or she should review Items 5, 6 and 7 to determine what his or her costs are to get the business open, talk to franchisees (see prior blog post on the questions to ask: Top 10 Questions To Ask Before You Buy A Franchise) and review the franchisor’s financial statements (which will be audited if the franchisor has been selling franchises for more than three years or is registered in certain states). A good franchisor, sales rep, consultant or broker will encourage this type of due diligence or validation and know that this benefits the candidate and thereby makes them stronger by having a good outcome when the candidate invests in the franchise opportunity. Check out my prior blogs on validating a franchise: Four Steps To Validate A Franchise.