By kelly | February 21, 2018

Understanding Franchise Earnings Claims

If you are you considering buying a franchise you probably want to know how much money you can make owning a franchise. Franchise earnings claims are your best bet at figuring that out before you purchase a franchise, but there are some things you should understand before you begin.

What is a Franchise Earnings Claim?

An earnings claim is any information you receive as a prospective franchise owner which allows you to attempt to predict a range or level of potential sales, costs, income, or profits. How much money you can make.

What Information Can Franchisors Legally Provide You With?

Often, people believe that by law, franchisors cannot provide prospects with any information on earnings potential. This is not the case at all. There are stringent franchise laws in place to protect both the franchisor and the franchise owner. In many states, the FDD (Franchise Disclosure Document) must be registered with a state agency in order for the franchisor to legally sell franchises in that particular state.

Most franchisors will not include earnings claims in their FDD. This is completely legal as well. Some franchisors simply do not feel comfortable publishing this data. In the FDD, a legal earnings claim, if made available will be in Item 19 of the document. Item 19 is based completely on historical data from the company’s units and may include the following information: various costs, ranges of sales at actual locations, statistical data about operations, and any other pertinent financial information. Item 19 is legitimate because it is a formal, written, historical earnings claim. Earnings claims that are not historical, written, or formal (filed with states) are not legal and cannot be accepted as legitimate. Earnings claims are more of a prospective presentation of data.

What Isn’t Legal?

Many prospective franchisees make the mistake of asking their franchise salesperson or consultant how much money they will make. A very common question, salespeople and franchisors cannot legally provide you with an answer. Whether you receive a scribbled number on a piece of paper or a range of figures within a conversation, do not rely on this information. In fact, the best thing you can do is not ask this question. The only legal form of an earnings claim is found in the FDD in Item 19. Item 19, as discussed earlier, is simply a historical review of costs, earnings, and other financial data and does not promise you any amount of money. It simply tells you how well the company’s units have done in the past.

Why is it illegal for a saleperson or a franchisor to estimate future sales and success of a new unit? For one thing, there are so many factors that play into the success or failure of a franchise unit. There is no way, based on the performance of other units, anyone can truly estimate how well a new unit will do. Secondly, it is not legal or safe for a salesperson or franchisor to even discuss how well their other units are doing because if a new unit fails, there is a possibility that in court the franchise owner could recall that individual telling them they would do well like the other units they spoke about. Legally, finances cannot be discussed anyplace other than Item 19 of the FDD.

How Do You Know You Are Making a Good Decision?

The process of buying a franchise should always include lots of research on your part. The best way to know you are making a sound decision is by asking questions, doing research, and then putting all the information together to come to your own conclusion.

So where do you find the most reliable information regarding earnings? The FDD is always one of your most valuable places to start:

  • Items 5 and 6 will tell you about fees and the structure of those fees.
  • Item 7 will give you the particulars on how much you will need to invest to become a franchise owner. The investment chart includes such information as types of locations, staff sizes, equipment, and inventory, and can be extremely useful as you try to project on how well your investment will do in your specific area.
  • As discussed earlier, if a franchisor chooses to include the information in their FDD, Item 19 will give you a formal, written, historical earnings claim.
  • Item 20 is a list of current and former franchisees and their contact information. This is the most valuable resource you have! Use this list well. Ask the franchisees, current and past, about their unit’s performance. They can and will give you factual information. Find out about their customer base, area of the country, what products/services did well and what did not. Gather the information together and then attempt to figure out whether the business will do well in the location you had in mind.
  • Finally, in Item 21 some companies will include a financial statement regarding company-owned unit performance. This information can be quite interesting and helpful to you as well.

There are so many variables that might be forgotten as the exciting and nerve-wracking process of buying a franchise unfolds. Read the FDD carefully, contact as many franchise owners you can (present and former), and decide for yourself whether a franchise will be a sound investment for you.

 

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