Understanding Item 19, Part 2: The 4 Types of Item 19’s
In our previous review of Item 19, we provided a general guide to items found within a company’s Item 19 Financial Performance Representation (formerly known as an Earnings Claim; also known as Article 19). In part 2, we review how these Financial Performance Representations can be useful and their limitations.
First, it is important to understand that the FTC does not require a franchisor to share earnings information in their Item 19 " it is an option. Today, about 50% of companies offer a Financial Performance Representation (FPR) in their Article 19. The rest of the franchise community does not provide any information in their Item 19. The primary argument for inclusion is that it assists perspective franchisees gain more information regarding the earning potential of the franchise system. The primary reasons against providing a FPR fall into one of three areas.
- Some franchise attorneys believe that an Item 19 opens the franchisor to increased risk of litigation.
- Some franchise systems do not collect this information and therefore they cannot reliably share the information with prospective franchisees.
- Some franchisors do not want to share this information because it is not flattering and it would not help them grow their system
At this point it makes sense to take a deeper dive into the different type of FPR’s. Over the years I have come to recognize that most FPR’s fall into one of four categories:
Partial FPR of Actual Data
This is the most common type of disclosure. Most franchisors collect top level data from their franchisees and they are comfortable with this type of disclosure. You can recognize this type of FPR because it normally includes Gross Sales Averages, Cost of Goods Sold, Lease Cost and/or possible Labor Cost, but does not include Earnings, Profit, or other bottom line information. Normally this information is divided into groups based on the age of the franchisee. A typical breakdown could include franchisees from 12 to 24 month, 24 to 36 months and franchisees in business for longer than 3 years. This type of information can be a helpful starting point
Complete FPR of Actual Data
Although rare, some franchisors provide complete FPR’s. This would include all of the income lines and all of the expense lines on the P&L. This type of FPR stands apart because the FPR will include bottom line earnings. It is exceptionally difficult for a franchisor to consolidate franchisees bottom line earnings; therefore, therefore, you normally find this type of FPR in franchise systems that have a large number of company owned locations. Since the company owned locations are all run a consistent set of books, consolidation can be done in a balanced and fair manner. In many ways this is the best type of FPR.
Partial FPR of Prospective Earnings
There are also companies that provide partial disclosure of prospective earnings. You can recognize these because the information will be top line and it will not be based on actual performance. It will be based on ‘anticipated’ performance. You can recognize this because the FPR will state, ‘If you sell this much, then your other cost should be X.’ The fact that this is based on an assumed sales level does not really give you any information regarding what is actually occurring and therefore is significantly less valuable.
Complete FPR of Prospective Earnings
The final example is a company that provides a completely assumed set of books. You can recognize this because the FPR will state, ‘Here are two or three different sales levels and the profit you could make if you are able to make these levels of sales’. Again, there is no connection to actual performance and therefore the value of this type of FPR needs to be significantly discounted.
Don't Rely Completely on Item 19 - Do Your Homework
Strange as it may sound, mistakes often stem from too much focus on the FPR. Even though some companies may provide significant financial information in their FPR, you cannot fully understand the earnings potential of a franchise system by reviewing the FPR. It always requires in-depth conversations with franchisees following the approach found in Chapter 12 of The Educated Franchisee. By speaking with franchisees you can build a comprehensive earning statement that is both accurate and educational. The Financial Performance Representation found in Item 19 can be an effective starting point but it is up to you to put time and effort into discovery of the complete and actual performance.
Missed Part 1? Read How Much Will I Make With a Franchise, Understanding Item 19 here.