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How Much Can I Make as a Franchisee?

In this first of two columns, our expert discusses the hows and whys of getting earnings claims from your franchisor.

Q: I'm trying to determine exactly how much money I can make with a franchise company I'm investigating, but I'm having trouble getting the franchisor to answer this question. Every time I bring it up, they avoid the topic and mention something about the FTC having rules against sharing this information. Can this be right? How am I supposed to get this information? What is a reasonable level of income to expect from a franchise?

A: This is one of the real quandaries of investigating most franchises. You're not about to invest until you know how much you can earn; the franchisor probably has the best data to answer this question accurately, but they usually won't tell you a thing. I agree it doesn't make much sense when you look at it this way.

The early history of franchise sales in the United States contained many instances of abuse when unjustified or misleading earnings claims were used to sell franchises. In 1979, Congress passed legislation authorizing the FTC to regulate the franchise industry to try to stop any such bad practices.

The current FTC rules do not forbid a franchise company from supplying information about the earnings that can be achieved in their business. They do, however, have stringent rules on how this information can be given to a prospective franchisee.

Basically, any franchise that wants to provide this information must put it in writing in their UFOC disclosure document, in Item 19. It is essential for the franchisor to make sure that the data provided is as accurate and representative as possible, and they need to clearly label any assumptions or qualifications on the data provided.

Assuming they meet these two requirements, they are free to provide whatever earnings information they want to a prospective franchisee in terms of sales, expenses, cash flow and income. Since it's this easy, it begs the question of why more franchisors don't do it.

The answer is twofold. First, producing an earnings claim does involve effort and expense for the franchisor. Second, the results (given that they have to be accurate and not misleading) may not be attractive enough to assist in the recruiting of new franchisees. If that's the case, having the FTC to hide behind gives franchisors a ready excuse to keep this accurate data from prospective franchisees.

Whether a franchise provides earnings information or not, you'll want to confirm this data in conversations with existing franchisees of the system. Call them and ask. Make sure you select enough franchisees at random to get a clear idea of the averages and ranges for earnings in the system. In next month's article, I'll discuss tried and true techniques you can use to get this information from existing franchisees during these calls.

You also ask about a reasonable level of earnings for a franchise business. I think most experts would answer this question relative to the amount of the total investment required by the franchise. You would probably expect the income to increase as the investment required by the franchise increases, though this is often not the case in franchising.

A good rule of thumb is that you can earn 10 to 15 percent on your money over time in a totally passive investment. Since most franchises require you invest your time as well as your money, you should expect a return significantly higher than this level in order to justify the investment. This higher return will also offset the higher risk involved in this type of investment. You can consider earnings of at least 30 percent of your total investment on an annual basis as a reasonable return, and expect to reach this level, at the latest, by the third year of operation of the business.

NEXT MONTH: The best way to get earnings information.

Read "Fortune Telling and "Understand Franchise Earnings Claims" to learn more.

Jeff Elgin has almost 20 years of experience franchising, both as a franchisee and a senior franchise company executive. He's currently the CEO of FranChoice Inc., a company that provides free consulting to consumers looking for a franchise that best meets their needs.

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