Understand Franchise Earnings Claims
Where to find franchisors' financials and what they mean
Prospective franchisees are often surprised to find that most franchisors won't say how much money can be made with their franchises. It's not that franchisors are legally prohibited from providing any information about earnings potential (a myth repeated by some franchise salespeople and brokers). Many franchisors choose not to, and they have a host of reasons-some good and some not so good.
Every U.S. franchisor is, however, required to provide prospective franchisees with a disclosure document called the Uniform Franchise Offering Circular, which includes information about the franchisor and the franchise it's offering. If the franchisor has chosen to include earnings information in its UFOC, you'll find it in Item 19.
While the format and type of earnings claim information provided by franchisors, even those within the same industry segment, vary greatly, in general the UFOC has information on ranges of sales at their locations, information on costs, statistical data about operations and other important financial information. (Remember, though, that your location may not perform as well as others in a franchise system.)
Even if the franchisor provides you with detailed earnings information in Item 19 of the UFOC-and, more important, if they don't-you can use the information provided elsewhere in the document to help you estimate earnings. These include:
- Financial statements: Some franchisors offer their financial statement information on company-owned unit performance in Item 21 or as an addendum to the disclosure document.
- Structure of fees: Not every franchisor bases its royalties as a simple percentage of gross sales. Often their fees are based on formulas using other performance criteria. You'll find information about fees in Items 5 and 6.
- Investment: Item 7 of the UFOC provides information on how much you'll need to invest to become a franchisee. Typically, this includes an investment chart as well as information on staff size, types of locations, equipment or inventory-a gold mine of information from which you can build local projections.
- Other franchisees: Item 20 provides a list of current and former franchisees, with their contact information. Often the most accurate information about unit performance comes from franchisees actually operating locations. Put together a list of questions and call them.
Many franchisors use the Internet to publish press releases containing information about unit performance, but you can find news articles about the company on the Web as well. If the company is public, review its SEC filings. The reports are available from most stockbrokers or can usually be obtained from the franchisor's Web site.
It's also important to understand how your franchisor's competition is performing. Robert Bond publishes a comprehensive compendium of earnings claims made by franchisors titled How Much Can I Make?(Source Book Publications). For more information, go to www.worldfranchising.com.
Investing in any franchise is an important decision, and putting together enough accurate information takes some time and effort. You should never rely on one source to make your decision, especially when so much additional information is available to you.
If you are not a sophisticated investor, seek the assistance of a franchise attorney, a consultant or an accountant. They can help you dig through the data and put together a meaningful projection for your future business. It's usually better to avoid asking for assistance from a franchise broker, as they work for the franchisor and therefore have an interest in your purchasing the franchise. Stick to independent advisors who have your interests in mind.
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 recently co-wroteFranchising for Dummies(IDG Books) with Wendy's founder Dave Thomas.