For those of you who have been following us along, we're going back to the Franchise Disclosure Document (FDD) and we're covering the granddaddy of all the Items (of the FDD), which is Item 19. We're going to learn what Item 19 is, why it's important, and give you some advice on how to follow up on Item 19 if you're evaluating a franchise.
What is Item 19 from a 10,000-foot view?
Item 19, it's the biggie, it's the big kahuna. Item 19 is financial performance representations. And this answers the question that every single candidate asks us, which is, how much money can I make? Item 19 directly covers the revenue side of the equation.
Why Item 19, it’s essential that you understand what it is, where it is, and what it means.
So when a candidate starts looking at Item 19 of the FDD, the financial representations, here's the thing, every single franchise that you look at this is going to be presented differently. There's no one set format for how to present the Item 19 financial representations. That's why you really need to understand what it covers which is how franchisees in that system are making money. It's NOT A GUARANTEE that you are going to make that money, but it is a representation of how the franchisees in that system are making money. We view that as a real positive because what other business model you might investigate do you get to dive deep and really understand the numbers before you make a decision?
Let's just say you're looking for an existing business out there today and you want to try to figure out revenues, expenses, and so on and so forth, to make a decision to acquire that business, well that information is NOT that easy to find. It's very difficult to determine the authenticity of any numbers provided because in that scenario that information is not overseen by anybody. Meaning that there's no governing body that says whether that information is even partially correct. So in the franchise model, there’s Item 19, which is overseen by the Federal Trade Commission (FTC). The FTC makes sure that if a franchise is going to include this in their Item 19, the numbers have to be substantiated by the actual performance of some of their operating franchises that they're including in those numbers.
These are NOT projections, these are not estimates, these are real-life numbers that franchisees in the system are doing. So you're going to want to dive deep and understand what is being presented and how is it being presented. Is it a certain group of franchisees? Is it all franchisees? Every FDD that you look at will present this information in a slightly different way,
Is item 19 a mandatory item in a Franchise Disclosure Document?
The answer is NO. Many franchises don't have an Item 19 and there really could be different reasons for that. For example, the franchise that we selected (17 years ago) actually did not have a Franchise Disclosure Document.
It wasn't called the FDD back when we actually evaluated our franchise, it was called the Uniform Franchise Offering Circular (UFOC). One of the reasons why they may not have an FDD Item 19 today is they're an emerging brand. They don't have enough information to feel comfortable enough to present financial information in writing in a document. There are many other reasons why they might not report financial information for instance business opportunities generally do not have an FDD, they're not required to report and for some franchises, it's just difficult for them to really evaluate fairly what these numbers might look like. Meaning say it's a cash-based business and maybe it's hard to say if their franchisees are all reporting properly if they don't have a register. So it may be difficult to gather the information which is some of what we ran into with our franchise since it was an event-based model that many of the owner-operators out there couldn’t really give you concrete enough numbers for the franchise to feel confident enough to put that info in the FDD Item 19.
So, almost across the board, we really only recommend that our candidates explore franchises that do have an Item 19, especially if you don't have prior business experience, you are going to want to know what those numbers kind of look like. As you build a proforma and business plan, you will want some real-life data to make those decisions.
We’ve got some good news for you not directly related to that Item 19, we have a FREE ROI (Return-on-Investment) calculator on our website. This can be used to evaluate any franchise or business opportunity. If you can accumulate the correct information (which would be found in an FDD Item 19) this can give you some idea of what your return on investment might look like. Plug in the numbers and it can give you some information about what that franchise might look like based on numbers from the FDD. For non-franchise (or non-FDD Item 19) they'll give you some numbers from the business financial statements, but they really don't give you the net result of those numbers. You have to kind of figure that out on your own.
What exactly is included in Item 19?
As we have been mentioning, when you look at different franchise concepts, every franchise can decide how they want to present information in Item 19. Hopefully, you'll get to see revenue numbers, gross profits, net profits and expenses. We have looked over many Item 19s and we find that in general, most of them will certainly show you the top-level numbers and what your gross sales are across the board. Many times the numbers are broken out into different groups of franchisees, especially for a more established brand.
In general, most franchises will only report for those that have been in business one year or more because you have to realize your first year you're ramping up and everybody's going to be in a different situation. So those being in year one year plus, they'll almost always report that data. You may end up seeing the data from 1 to 5 years, 5 to 10 years, and 10 years plus so you can then see any trends or anomalies across that data.
They generally break it down by region. How does the West compare to the mid of the country or the East Coast? So every franchise can decide how they want to report that. We have found it very interesting and insightful sometimes in helping our candidates understand how those numbers are presented.
Are there any common exclusions found in Item 19 of the FDD?
If there are any exclusions, then it must be disclosed. That's the whole point, the franchise has to be open and honest and they can't kind of hide something underneath the rug, which is great (which may not be true for non-franchise businesses). But if they are intentionally excluding something, then you'll see it denoted in the small print.
So looping this back to our earlier statement about evaluating other types of non-franchise businesses, there's really nothing there governing those numbers (or presentation thereof). It's up to you to prove those numbers yourself. Meaning that there's no governing body overseeing the truth of those numbers showing in any documents provided by the other party. So again, when evaluating franchises, the nice thing about that is the numbers showing in an FDD are all governed by the FTC and these numbers have to be validated/substantiated before they can end up in Item 19.
What other business opportunities out there give you that opportunity to really know how a business is doing and allow you to substantiate in your evaluation the question “How much can I make”? Or when are you gonna get your investment back? You can use our return on investment calculator, take the numbers from an FDD, plug those in there and you can find out I'm going to break even in one year, three years, five years based on the numbers they're providing me. What a great way to be able to do real due diligence on a business opportunity.
Additional comments about the FDD Item 19
Of course, this item can seem very overwhelming in almost all cases. It's going to be the longest section of the FDD (most likely) and it's absolutely one that you need to pay particular attention to. You can, and should, use the Item 19 numbers when you get to the stage of validation and start talking to other franchisees to ensure that those numbers are valid and make sense. As you build your pro forma and business plan, you'll feel a lot more confident in plugging those numbers in after discussing them with other franchisees. So you absolutely want to validate these numbers when talking to the other franchisees as part of your due diligence process so you have the best opportunity to evaluate whether or not this is the right franchise or business opportunity for you.
In addition, we want to make clear to our audience that the Item 19 numbers are just a representation, although it comes from real accurate information, it is NOT A GUARANTEE. So if you see that average sales in a certain franchise you're looking at are $1.7 million, it doesn't mean that you, in particular, are going to make $1.7 million. It's NOT A GUARANTEE. Make sure you do your validation and work with someone such as us who can help you dive deeper, understand the numbers, and understand how you make money.
We have a statement that we always share with our candidates, which is “gross is for vanity, net is for sanity”. So some franchises, they'll focus so much on the top line, you can make $3.5 million, but what's going into your pocket? So always try and get those net numbers. Many times franchises do share that in Item 19 and sometimes do not.
So final disclosures. We are not franchise attorneys or accountants. As part of your due diligence, if you are not a financial person, please seek advice from professional advisors such as an accountant or a franchise attorney when evaluating any legal document including the Franchise Disclosure Document Item 19. Feel free to reach out to us regarding questions regarding FDD Item 19 or need assistance in determining if a franchise is truly a good fit for you.
What's Your Next? - Podcast
 | Author BioI’m Stacey Riska aka “Small Business Stacey”, your franchise placement specialist. I help aspiring business owners find the PERFECT franchise so they can get to the next level in life and business. |
