The Most Important Items in an FDD: Item 19 - Financial Performance Representations

When it comes to learning about the earning possibilities that come with a specific franchise brand, franchise candidates should read Item 19 of its Franchise Disclosure Document. This infamous section is referred to as “financial performance representations” and offers the best way to gauge the revenue potential of a franchise system based on the results of the previous year. As a result, it is often the first page a candidate flips to when reviewing a brand’s FDD.

“Item 19 is the only place where a franchisor can disclose how much franchisees make,” said Keith Gross, in-house counsel for the franchise brand Koala Insulation. “The unique thing about Item 19 is that it is presented at the discretion of the franchisor—it is not mandatory. While a franchisor is not required to make any FPRs, if they do, they must do so through Item 19. Franchisors are, with few exceptions, prohibited from providing any financial information that is not included in the FDD Item 19.”

Unfortunately for first-time FDD readers, not all Item 19’s are created equal. It is a case-by-case situation in which comparing numbers can be tricky. For example, some companies may report on all store revenue while other brands may only show how corporate stores are performing in the section.

There are important questions to ask when reading through an Item 19. Franchisors aren’t trying to mislead people, but the data can be confusing. Because of that, prospective franchisees need to know what to look for. 

“Instead of discussing the success of one top-earner, Item 19 should, ideally, be used to quantify what the business is capable of doing as a whole,” said Brent Dowling, CEO of franchise sales solution Raintree*. “The Federal Trade Commission requires that if the franchisors list any performance numbers, they must also show the number of actual units that have experienced those numbers compared to the entire sample size. Make sure to pay close attention to these numbers. If only a small percentage is hitting the high numbers, then the top producers are skewing the averages.”

Although a lack of Item 19 in the FDD can scare some candidates, it is not always a red flag. Often, it is because the brand is in its infancy and doesn’t want to mislead potential candidates with unrealistic expectations. For example, the first three franchise locations in the same area are always going to be profitable. However, opening that same brand in a new location is going to be harder to build out.

Prospects trying to evaluate how much they can make should study an Item 19 carefully, pay attention to exactly what’s being presented and, perhaps more importantly, what’s not being presented. Footnotes in Item 19 can offer additional information that can help explain exactly how the performance representation was calculated and what made up the data set or sample size.

One red flag that may come up when reading the Item 19 is the presence of carefully crafted “classes of franchisees” in more established franchise systems. “With new systems having fewer than 10 locations, the franchisor must disclose information for all locations,” said Gross. “Although more established systems with a large number of locations are prohibited from cherry-picking data to improve their apparent performance, they are permitted to report on sub-classes of franchisees (e.g. all franchisees open for greater than 36 months and offering all services offered under the system). This may narrow the report down to the most successful franchisees. A prospective franchisee should understand those subclasses and learn more about the excluded information.” 

All in all, Item 19 is meant to provide a generalized, ballpark assessment of the general mechanics of the business model—profitability structure, potential revenue, range in revenue—to give an overview of whether or not the business plan is close to what the candidate is looking to acquire. 

For a deeper understanding, franchisees should develop a list of questions and call as many franchisees in the system as possible to ask about their experience and financial performance, or at a minimum verify the information in Item 19. This, plus a fair amount of due diligence, will ensure the franchise candidate has the information they need to move forward with the big decision.