Q: I'm very
interested in investing in a franchise and met with several
franchisors. Each of them gave me a copy of they Uniform Franchise
Offering Circular--and Item 20 confuses me. The columns don't
add across. What's up?
A: We know. Blame
it on the regulators.
Item 20 may be the most important and at the same time the most
confusing section of a franchisor's disclosure document. It is
the place where prospective franchisees can generally find a list
of names, telephone and addresses of each of the franchisees
currently in the system, as well as a list of former
franchisees.
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While almost every franchisor lists every franchisee in their
UFOC, some don't, and for a very good reason--the disclosure
document would become too long and heavy. The rule on disclosing
franchisees allows the franchisor to limit the list to those
franchisees within the state where the offering circular will be
used. If there are less than 100 franchisees in the state, the
franchisor is required to list the franchisees in the contiguous
states until they get to that magic number. For most franchisors,
however, listing all their locations isn't really an issue, and
they simply provide a list of locations as an attachment to the
disclosure document regardless of what state the document is
intended for.
Regarding former franchisees, the company is obligated to list
the last known address and telephone number for each franchisee
that has left the system during the past year for any reason,
voluntary or involuntary--whether they were terminated, chose not
to renew their agreement or sold their business.
These lists contain some of the most important information a
franchisor is required to provide you, simply because it gives you
a way to reach the people with the answers to your most important
questions, including:
- Are you making money as a franchisee?
- How long before you were able to take a salary?
- What did it really cost to get into business?
- Does the franchisor provide you with the services they
promised?
- Would you have invested in this franchise today if you had the
information then that you have now?
These and a hundred more questions help you make the decision
about whether to invest or not. No matter what you can learn from a
franchisor directly, it's always satisfying to learn from the
actual operators what the real story is.
The list of former franchisees is of equal--some believe
more--importance. Former franchisees don't always leave because
they were unhappy. Some retire on all the money they have made and
are thrilled to have been a franchisee. But former franchisees
often are a great source for information--they can tell you what
they liked and what they did not like about being a franchisee, and
about issues current franchisees may not want to talk about. Keep
in mind, though, if the franchisee and the franchisor did not part
as friends, you may need to weigh the information.
Deciphering the Item 20
Charts
I need to be honest with you--the current charts are often so
confusing and subject to potential manipulation that some
professionals think they don't really provide any useful
information at all. Others go much further in their criticism.
In one section of Item 20, the franchisor is required to
provide, for each of the last three years, how many locations have
been:
- Transferred--or had a change in controlling ownership
- Cancelled and terminated
- Not renewed
- Reacquired
- Left the system or been abandoned
- Opened at the end of the year
Seems like important information, because in one chart you
should be able to see how well the system is growing from year to
year. You can see why units have changed hands or closed. And you
can see that information on a state-by-state basis. Right? Not
really.
A location can be listed in more than one category; therefore,
the columns don't add up, which in itself is confusing and
misleading. A location might be listed as a transfer simply because
the franchisees gave the business to their children. It might be
listed as a transfer because they made so much money, they sold the
business and retired to Florida. Or they could have sold the
franchise because they lost every dime. That same unit may have
been purchased by the company and then resold to a new franchisee
that year.
Changes can and often do fall into several categories, and the
chart doesn't add up. When you couple that with the fact that
the categories don't distinguish when changes are good or bad,
the chart has limited value.
What is important is whether the system is growing and whether
the franchisees and the franchisor are profitable and stable. The
last column--Franchises Operated at Year End--will give you part of
the answer. The rest you get primarily from your interviews and
looking at the financial statements of the franchisor.
The franchisor must also disclose, by state, the number of
company-owned locations that were opened and closed during the past
three years. That information is useful, because it can tell you
whether the franchisor has any of their own "skin in the
game" by operating locations themselves.
Of little value at all and potentially the most misleading part
of the disclosure document is the projected units to be opened. I
consider it the Faith Popcorn section of the offering circular.
In this section, franchisors get to guess how many units will be
opened in each state next year. This doesn't mean they have
signed franchised agreements for every franchised location they
predict will open. Nor does it mean they have a signed lease and
are in the process of building out the new company-owned locations.
It often doesn't mean anything more than somebody made a guess.
They may not have a franchise candidate for that state or even be
advertising for franchisees in the state. It's a guess, and the
franchisor can guess high or low--the future will be the judge of
how accurate they were.
Even the section that discloses how many people have signed
franchise agreements but have not yet opened can be misleading.
Some franchisors include franchises covered by area development
agreements, while some only list those individual unit agreements
that have actually been signed. One franchisor may be aggressive,
while another franchisor may be more conservative. For the
prospective franchisee, this peek into the future does not really
provide any value.
My advice: Don't spend too much time trying to understand
the charts in Item 20. They baffle even the pros. If you have
questions, ask the franchisor. Use Item 20 primarily for the
contact information on the current and past franchisees. That is
its real value.
Michael H. Seid is managing director of Michael H. Seid &
Associates, a West Hartford, Connecticut- and Troy,
Michigan-based management consulting firm specializing in the
franchise industry. Seid co-wrote Franchising for Dummies(IDG Books) with
Dave Thomas, the late founder of Wendy's, and serves on the
International Franchise Association's Board of
Directors.
The opinions expressed in this column are
those of the author, not of Entrepreneur.com. All answers are
intended to be general in nature, without regard to specific
geographical areas or circumstances, and should only be relied upon
after consulting an appropriate expert, such as an attorney or
accountant.