But…how much money am I going to make?
This is the primary question a prospective franchisee will ask before signing on the dotted line.
As a franchisor, it is in your best interest to respond, especially if your business has been profitable. In the franchise world, the mechanism by which to respond is called the Item 19.
What is an Item 19?
The FTC allows franchisors to make oral or written representations about the financial performance of their businesses. While you are not required to make these representations, if you do, you must include them in your FDD in the form of what’s called an Item 19.
The Item 19 is your opportunity to make certain representations about your business’ financial health. If you opt to exclude an Item 19, you are not permitted to make any representations about your business’ financial performance to your prospective franchisees.
What is a Financial Performance Representation?
What constitutes a “financial performance representation” can vary wildly. It can be as granular as stating, “Our 200 franchisees earn an average net profit of X,” or as broad as the following:
- “Franchisee X just made Y in sales,”
- “Franchisee X quit his full-time job to run his business,” or
- “Franchisee X bought a yacht when he sold his business.”
Each of these statements gives prospective franchisees a concrete, tangible sense of what they can earn if they jump on board. These types of representations, whether written or oral, are all permissible and legal if they are included in an Item 19. However, if you make these representations (even in a casual, passing comment), but fail to include them in an Item 19, you risk exposure in the form of civil liability, fines, or, depending on the enforcement mechanisms in your state, a moratorium on operating your business in that territory.
A financial performance representation is not a guarantee that your prospective franchisee will achieve certain financial metrics. But as you present historical data or make reasonable projections, you help your prospective franchisees to have realistic expectations for their financial success.
Why Should I Include an Item 19 in My FDD?
Generally, it’s advisable to include an Item 19 in your FDD. In short, if your business’ numbers are strong, you have every incentive to do so: Including an Item 19 will only help you onboard the best prospective franchisees possible and give you a competitive edge.
However, there are other reasons why you might want to include an Item 19.
- You should control the narrative – not your franchisees. First and foremost, if you do not include an Item 19 in your FDD, your prospective franchisees will consult existing franchisees to discuss their profitability as franchise owners. If your system is new or you have few franchisees, this talk among franchisees may not provide the clearest picture of the strength of your system. As a franchisor seeking to grow your system, you should be the one making the disclosures so that you control the narrative about your business’ financial health.
- You will reduce risk. If you don’t include an Item 19 in your FDD, you increase your liability exposure. Consider that sales personnel or others who work on your behalf may make intentional or inadvertent representations about your business’ performance which, if you failed to include an Item 19, automatically places you in violation of franchise laws.
- An Item 19 provides a concrete profile of your business. An Item 19 creates a clear avenue for providing performance information, which will help your prospective franchisees make smarter decisions about whether to contribute to the franchise system. It will also expedite the process by giving them concrete, tangible information about their potential ROI and the risks of buying into the business.
- Your disclosures instill trust. Including an Item 19 can inspire confidence in your prospective franchisees by setting a standard of transparency and honesty. In some cases, if you do not include one (but your competitors do), prospective franchisees may wonder what you’re hiding.
Helping your franchisees compare your business favorably to others can give you a competitive edge. It can provide you with instant credibility if your company has a strong track record of earnings and can serve as a powerful sales tool – not to mention, it can substantially reduce your liability exposure. If you have further questions about the Item 19 generally, or your business specifically, reach out to an experienced franchise attorney for guidance.