A Word on Financial Performance Representations

    By , Franchising

    Recently, a number of my franchise colleagues have been debating on whether it is ever a good idea to buy into a franchise system that does not make any sort of financial performance representation (“FPR”) in its Franchise Disclosure Document. The nature of social media tends to provoke people into making grand pronouncements, so it is not surprising that some commenters took the position that they would advise any franchise prospect to avoid a franchise system without an FPR. Like all grand pronouncements, there is an element of truth in that thought, but it is a simplification of reality that deserves to be carefully examined.

    As a starting point, it is fairly well-accepted that a prospective franchisee should want to see as much data about their likelihood of success as possible. And, franchisors that have a good story to tell will improve their sales process (and, potentially, the quality of franchise prospects) by providing that data. But, what if the franchisor is new or — for some reason — does not have sufficient data to produce a meaningful FPR? Should the prospect stay away? Should the franchisor come up with dubious numbers?

    As far as prospective franchisees go, the answer has to be “it depends.” An FPR is only one piece (undoubtedly an extremely important piece) of the data that a prospect should include in their due diligence. They should still be contacting existing franchisees to glean whatever they can about their experiences — financial and otherwise. They should still be trying to determine whether the location of their potential business will be a good fit for the business. They should still be evaluating the local market. They should still be evaluating whether the operational skill set needed to succeed in the business is a match for them. The list goes on. Without an FPR to work with, getting comfortable with your due diligence is harder, but not impossible.

    For franchisors, the answer is a little easier. Under no circumstances should a franchisor dress up dubious data as an FPR. That is a recipe for disaster for both the franchisee and the franchisor. A harder question is whether there is some form of limited FPR that might be useful to prospects. For example, if reliable revenue data is not available, but the amount of an average sale is, is that a useful metric? Is it misleading? Is there any circumstance where a projection (as opposed to historical data) would make sense? Any franchisor in this situation has to be careful. It is probably better to omit a claim if it has a reasonable chance of misleading a prospect. But, if they can come up with something that is useful and not misleading — but still falls short of telling the full story — it probably makes sense to do that.

    In the end, due diligence requires diligence — not a blind reliance on grand pronouncements.

    The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2024.