Buying A Franchise:
A Consumer Guide
... Continued From Previous Page
Earnings Information
You may want to know how much money you can
make if you invest in a particular franchise system.
Be careful. Earnings information can be misleading.
Insist on written substantiation for any information
you may receive that suggests your potential income
or sales.
Franchisors are not required to disclose information
about potential income or sales, but if they do, the
law requires that they have a reasonable basis for
their claims and that they make the substantiation
for their claims available to you. When you review
any earnings claims, consider:
Sample Size
Say a franchisor claims that franchisees in its
system earned $50,000 last year. The claim may be
deceptive if it doesn’t represent the typical earnings
of franchisees. The disclosure document should
tell the sample size and the number and percentage
of franchisees who reported earnings at the level
claimed.
Average Incomes
A franchisor may claim that the franchisees in its
system earn an average income of, say, $75,000 a year.
Average figures tell very little about how individual
franchisees perform. An average figure may make the
overall franchise system look more successful than it
is because just a few very successful franchisees can
inflate the average.
Gross Sales
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Some franchisors provide figures for the gross sales
revenues of their franchisees. These figures don’t
really tell about the franchisees’actual costs or profits.
An outlet with a high gross sales revenue on paper
may be losing money because of high overhead, rent,
and other expenses.
Net Profits
Franchisors often do not have data on net profits oftheir franchisees. If you get net profit information,
ask whether it includes information about company-
owned outlets; they often have lower costs because
they can buy equipment, inventory, and other items
in larger quantities, or they may own, rather than
lease, their property.
Geographic Relevance
Earnings may vary with geography. If it’s reported
that a franchisee earned a particular income, ask
about the franchisee’s location. The disclosure
document should note geographic or other
differences among the group of franchisees whose
earnings are reported and your likely location.
Franchisees’ Backgrounds
Keep in mind that franchisees have different skill sets
and educational backgrounds. The success of some
franchisees doesn’t guarantee success for all.
Reliance on Earnings Claims
Franchisors may ask you to sign a statement—
sometimes presented as a written interview or
questionnaire—that asks whether you received any
earnings or financial performance representations
during the course of buying a franchise. If you heard
or got any earnings representations, report it fully
during an interview or on a questionnaire or other
statement. If you don’t, you may be waiving any
right to contest the earnings representations that
were made to you and that you used to make your
decision to buy.
Financial History
The disclosure document gives important
information about the company’s financial status,
including audited financial statements. You can
find explanatory information about the franchisor’s
financial status in notes to the financial statements.
Investing in a financially unstable franchisor is a
significant risk; the company may go out of business
or into bankruptcy after you have invested your
money.
It’s a good idea to hire a lawyer or an accountant to
review the franchisor’s financial statements, audit
report, and notes. They can help you understand
whether the franchisor:
- has steady growth
- has a growth plan
- makes most of its income from the sale of
franchises
or from continuing royalties
- devotes sufficient funds to support its franchise
system
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VI. Before You Sign
The Franchise
Agreement
The company’s disclosures may change between the
time you receive the disclosure document and the
time you sign the franchise agreement. For example,
the company may have updated its disclosures; it is
required to do that at least annually after its fiscal
year ends. You have the right to ask for a copy of any
updated information before you sign the franchise
agreement. An updated disclosure document may
indicate the filing of new suits by or against the
franchisor, changes in the franchisor’s management
team, new financial data, and more current financial
performance data, among other information.
Additional Sources of Information
Accountants and Lawyers
In addition to reading the company’s disclosure
document—including any updates—and speaking
with current and former franchisees, consider talking
to an accountant and a lawyer. An accountant
can help you understand the company’s financial
statements, develop a business plan, assess any
earnings projections and the assumptions they’re
based on, and help you pick a franchise system that
is best suited to your investment resources and
your goals.
A lawyer can help you understand your obligations
under the franchise contract. These contracts
usually are long and complex. A contract problem
that arises after you have signed the contract may
be very expensive to fix—if it can be fixed at all.
Choose a lawyer who is experienced in franchise
matters, but rely on your own lawyer or accountant
for a recommendation, rather than the franchisor’s
recommendation.
Banks and Other Financial Institutions
These organizations can offer an unbiased view of
the franchise opportunity you are considering. They
should be able to get a Dun and Bradstreet report or
similar financial profile of the franchisor.
Better Business Bureau
Check with the local Better Business Bureau
(BBB) in the city where the franchisor has
its headquarters. Ask whether there are complaints
on file about the company’s products, services, or
personnel.
Government
Several states regulate the sale of franchises. Check
with the state office that regulates franchising—it
may be the Office of the Attorney General—for
more information about your rights as a franchise
owner in your state.
The Federal Trade Commission (FTC) enforces
the Franchise Rule. The FTC publishes a number
of business guides—for example, Getting Business
Credit , Dot Com Disclosures,
Business Guide to the Mail and Telephone Order
Merchandise Rule, and Complying with the Telemarketing Sales
Rule that may be helpful to your business.
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