Franchise Basics: Considerations, Calculations and Consultations

You think a franchise might be right for you. You can’t wait to cut the ribbon and start running your business. But to avoid false starts, it makes sense to spend more time in the beginning stages.This article is the FTC’s fourth Franchise Basics Series – Covers the key steps to take before you head off to compete: 1) carefully evaluate the key documents that may (or may not) be attached to the franchise disclosure document, 2) carefully review the financial performance statements contained in the franchise disclosure document; 3) Review every detail of the transaction with an experienced attorney and accountant.

Evaluate franchise documents.

this third post inside Franchise Basics Series covers key points to consider when studying Franchise Disclosure Document. But FDD is where you start. As the Consumer Guide to Franchise Buying explains, the FDD is just one of three key documents you need to evaluate.The second one is Franchise Agreement Itself – a binding contract between you and the franchisor that should be attached to the FDD. The franchise agreement will usually reiterate some of the information in the FDD – your territory, franchisee payments, advertising and marketing standards, use of trademarks, performance standards the franchisor will require you to adhere to, renewal terms (including whether you may be required to sign a franchise operating agreement). New franchise agreement (with materially different terms) or termination rights, etc. Any discrepancy between what is in the FDD and what is stated in the franchise agreement is a clear red flag.

Additionally, some time may pass between the time you receive the FDD and the time you are ready to sign the franchise agreement. Do not approach the dotted line without asking the franchisee whether the seller has made any updates to the FDD or whether there have been any changes to the financial performance information contained in the FDD. If so, be sure to obtain a copy of any updated information and study the document carefully. Also ask the franchisor if there are any differences between the franchise agreement that comes with the FDD and the franchise agreement you need to sign. Confirm this by carefully reading them side by side. If there are material differences, the franchisor must give you more time to review the changes before you sign the agreement.

The third important document to review is the franchisor’s documents Operation Manual. The operations manual includes the specific details of how you need to operate your franchise – include Hours and days of operation, interior decoration, uniforms, equipment, mandatory suppliers and other requirements have a profound impact on day-to-day management.Federal Trade Commission Franchise rules Franchisors are not required to provide their manual, but if the franchisor is unwilling to share it, it may raise another red flag. Another factor to consider is that the franchise agreement may give the franchisor the right to change the operations manual at any time. These unilateral changes may include remodeling, revised payment systems, or new fees and products—all of which may mean significant additional costs for franchisees.

Review financial performance statements.

Article 19 of the FDD deals with financial performance statements – claims made by the franchisor regarding sales or revenues. The Franchise Rules do not require the franchisor to provide this information, but if the franchisor makes a statement of this nature it must be in Item 19.If the franchisor or any franchise seller Raise a red flag when something is said about sales or revenue during a discussion with you, but those statements are not in the FDD.

Here are some other key considerations when looking at financial performance representations.

• potential income. If a franchisor makes claims about potential revenue or sales, the law states it must have a “reasonable basis” to support those claims. It is not enough to have a hope or a premonition. They want hard evidence. They must also tell you the sources and limitations of the information they rely on and any significant assumptions on which the claims are based. You have a legal right to obtain written evidence to support their claims, so be sure to ask.
• average income. If a franchisor tells you that its franchisees’ average annual income is $75,000, that doesn’t tell you much about the performance of individual franchisees.Calculating earnings this way allows results from some very successful stores to mask disappointing results from other franchises
• Total sales. Providing a franchisee’s total sales can also be deceptive because it does not take into account its actual costs or profits. Stores with high paper sales may lose money due to high overhead, rent and other expenses.
• net profit. Franchisors often do not have data on franchisor net profits.But if you get that information, ask if it’s based on results from company-operated outlets.If so, please keep in mind that these results may differ from your own Because the costs of company-operated stores are usually lower.
• geographical relevance. Earnings may vary by geography. If the franchisor provides sales or revenue data, ask if the data comes from franchisees in your area. Additionally, consult the FDD, which should indicate if there are geographic differences between the franchisee reporting revenue and your intended location.

An important fact check on any revenue claims made to you by the franchisor will be for you to have in-depth discussions with current and former franchisees listed on the FDD or those you identify from other sources. If their results don’t match what the franchisor tells you, that’s another red flag.

The franchisor may ask you to sign a statement (sometimes in the form of a written interview or questionnaire) stating In addition, ask whether Any income or financial performance statements you receive during the purchase process Franchise. If they provide you with any information about how much revenue your franchise may earn, report it fully. Don’t feel pressured into saying otherwise.If you are encouraged not to report income statements, this is a red flag. Additionally, you may waive any right to dispute claims of income used by you to make your purchasing decision.

Consult an attorney and accountant.

expected Franchisees may haveea legal background or finance experience, but regardless, all potential franchisees should Consult an attorney and accountant before deciding to purchase a franchise. Think of it this way: Many surgeons need to remove the appendix, but they don’t know how to do it themselves. Hire an experienced attorney to review the franchise disclosure document, operations manual, and franchise agreement with you. If you would like to change the terms of your franchise agreement, discuss this with your attorney. If the franchisor is unwilling to negotiate, this could be a bad sign for the future.

Also consider consulting an accountant to review the franchisor’s financial condition and any financial performance statements. When you look at your balance sheet line by line, your accountant may be able to read between the lines—the “good stuff” is often hidden in financial documents. Even the most sophisticated industry giants won’t make major financial commitments without discussing them with independent experts. Prepaying attorney and accountant fees can save you thousands (and a thousand headaches) down the road.

next in Franchise Basics: What should you do if you notice suspicious behavior related to franchise sales? And check out the entire series: