Everyone wants to know when and how much money they will make if they invest in a particular franchise. However, franchisors are prohibited from making earnings claims of any kind that are not disclosed in their Franchise Disclosure Document (FDD). This limits franchisors from discussing financial information in any real detail with franchise candidates.
These laws are designed to protect the individual investor. And, they do just that, but they also make it harder for a investor to get the financial information they want and need. Let’s take a closer look at where some related financial information can be found.
Key Franchise Disclosure Document (FDD) Items
The Federal Trade Commission requires that a franchisor update the FDD each year. A candidate must be provided with a copy of the FDD at least 14 days before a candidate can purchase a franchise.
The FDD is composed of 23 standard sections referred to as items 1-23. I encourage my clients to initially focus on the specific sections below, and not become overwhelmed by the entire FDD document.
Item 2: Business Experience of Management
Item 3: Litigation (anything in the last 10 years or pending)
Item 7: Estimated Initial Investment
Item 19: Financial Performance Representations Related to Franchisees
Item 20: Franchise Unit Count by State for the Last 3 Years (outlets)
Items 21: Audited Financial Statements of the Franchisor
Item 7 Estimated Initial Investment
This table provides an estimate of the expenses required to get a new franchise up and running. For each expense item, the franchisor will provide a cost range that is based on what the most recent franchisees have experienced.
- Pay close attention to working capital. Many franchisors will only provide an estimate of working capital required for the first 3 months. Some of the top performing brands will list working capital estimates for 6-12 months, which is a much more realistic timeframe.
- One of the most common reasons for business failure is undercapitalization. Do not assume you can get the business up and going for less than what is listed in the Estimated Initial Investment table. In fact, if you live in a high cost of living area, then assume that your total investment will be closer to the highest numbers in the range.
- During the evaluation process, my clients will talk to several franchisees (see Franchise Validation below for more info). At that time, it is important to ask franchisees about their start-up costs to validate the information provided by the franchisor in this section.
Item 19 Financial Performance Representations
Less than 50% of franchisors provide any significant financial information on how well their franchisees are doing financially. The good news is that more and more franchisors are providing more information each year.
It is no coincidence that the top performing brands are more likely to share more detailed information in this section. Be wary of those brands that provide little or no information in this section.
- Many franchisors will share revenue information for franchisees that have been in their system for at least one full year of operation. For example, they may provide you with average annual revenue by quartiles.
1st Quartile Average Revenue (top 25%) $850,000
2nd Quartile Average Revenue $710,000
3rd Quartile Average Revenue $595,000
4th Quartile Average Revenue (bottom 25%) $450,000
- The best franchisors recruit new franchisees that match the profile of their top performing owners, and avoid the profile of their bottom performers.
- Be careful what you conclude from this section of the FDD. It is very important to put the data in perspective regardless of the level of detail provided. Also, the data provided will not tell you "What type of performer you will be in this brand?" In other words, how well do you match the profile of the top performers.
- How do you compare yourself to top performers? A franchisor should share with you the characteristics of their ideal candidate, which summarizes their top performers. Also, talk to top performers in validation and ask the right leading questions.
Franchise validation is a critical stage that is late in the learning/evaluation process, where my clients get to talk directly with existing franchise owners of a brand. This is where we dig in with multiple franchise owners to understand their stories and specifically financial performance, which provides “real data” of the potential financial performance of a brand.
Take Advantage of Free Professional Help
Get help from a professional franchise consultant like myself with 25+ years of diverse business management/ownership experience. I am fortunate to have a wealth of resources and insider knowledge at my disposal to help pre-screen franchise brands.
The reality is that some franchises are amazing, some are mediocre, and some are bad apples. Working with me as a coach, my client's do not waste time with poor performing brands and they learn what to look for in evaluating their options. This makes what could be a difficult process much more manageable.
Pick wisely though, too many people dabble in the franchise consultant field and do a poor job. It’s a shame because the bottom 90% really do drag down the top 10%.
I recommend that you avoid those with sales background with little to no operational franchise experience. And, beware the ghost written franchise book author. If I am overbooked, then I am happy to recommend a professional for you. Feel free to contact me with any questions.
You also may find the following webinar replay of interest in helping you determine how much money you can make when investing in a franchise.