Evaluating Potential Earnings of a Franchise
April 4, 2023
Buying a franchise could be the best decision you ever make. But like with any major financial decision, there is much to consider before you make everything official. A couple of key matters you should assess are: what are your income goals, and how can investing in a franchise help you meet them? Evaluating the franchise’s potential earnings is a crucial step to take before you invest, especially if you require a specific minimum annual income to meet your needs or provide for your household.
If you're considering investing in a franchise, you deserve to have reliable and accessible counsel so you can make a confident decision about moving forward. The experienced business franchise attorneys at Bundy & Fichter PLLC can answer your questions and guide you toward your goals.
Understanding the Franchise Disclosure Document (FDD)
Before investing in any franchise, you have the right to know details about the entity you’re looking to buy into. The franchisor is required to provide to you its Franchise Disclosure Document (FDD) upon request—even before you submit an “application”. In this document, they’re required to disclose 23 pieces of information—referred to as “items”—about the franchise. Some key items discussed in an FDD include:
Franchisor’s background (FDD Item 1), which will tell you about the franchisor, including how long the franchisor has been in business and if there are any special licenses, permits, or legal requirements you’ll need to fulfill before purchasing the franchise.
Bankruptcy (FDD Item 4), in which the franchisor must disclose if they have declared bankruptcy within the last ten years, or if any of its affiliates or executives have.
Initial and ongoing costs (FDD Items 5-7), which should describe any initial deposits or fees that may be non-refundable, the estimated cost to get the business up and open and running, along with all ongoing costs like labor, rent, and advertising.
Financial performance representations (FDD Item 19), where the franchisor can provide some insight about potential earnings, and perhaps some actual figures for the outlet you’re thinking of buying. However, information about sales or earnings is not required.
Ultimately, each item in the FDD should help you develop a deeper understanding of the franchise. If the franchisor includes Financial Performance Representations, this knowledge may help you draw conclusions about the earnings your investment could generate. The franchisor is required to give you the FDD at least fourteen days before you make any legal or financial commitment to them.
After receiving and reading the FDD, you are fully within your rights to seek clarification about any information it contains. If the franchisor does not address your concerns of claims that it is not allowed to address them, you may want to consider whether that franchise is a good match for you.
Franchisor Financial Disclosure Requirements
It's important to note that the franchisor is not required to disclose information about potential income or sales in FDD Item 19. If the franchisor does provide a financial performance representation, then they are required to also disclose:
the source of data that supports the representation
any significant assumptions on which the claim is based
To further determine whether their financial performance representation is reasonable and applicable to how you plan to operate your business, consult an accountant or a knowledgeable franchise attorney. If the franchisor does not provide financial performance information you may want to consider why. Consider whether, if they were proud of the information, they would want to disclose it.
Evaluating Typical Financial Performance
It’s important to have an idea of how much money you can earn from investing in a franchise so you can set your goals and build any business strategies accordingly. Gathering information from the FDD will be helpful, but always treat any provided insight as a starting point when evaluating typical performance or your potential earnings. For instance, the franchisor may provide representations of the following data:
Average Income. Say the franchisor claims that their franchisees earn an average annual income of $90,000. While this is a nice number, remember that averages don’t always reflect typical performance. Impressive average figures can simply be the inflated result of a few high-income franchise locations amongst a pack of less-high-earning ones. In addition, unless the franchisor clearly defines the word “income”, you may not be able to determine whether they are referring to “gross revenue”, “gross profits”, or “net profits” or something else.
Net Income. If you get net profit information, clarify whether or not it’s based on company-owned outlets, as these locations often have lower costs because they may own their property instead of lease it. These locations may also be able to purchase equipment and other items in bulk. Company-owned outlets also may have been in business for a number of years, and the company may have closed underperforming outlets, thus inflating the averages.
Gross Sales. When figures for franchisees’ gross sales are provided, they don’t say much about actual costs or profits. A location with high gross sales could always be losing money in other ways, perhaps due to rent or high overhead.
The franchisor may ask you to sign a statement asking whether you received any financial performance representations. Such statements are prohibited in many states. If a franchisor asks you to sign one, you should immediately consult with an experienced franchise attorney before signing it.
Why It’s Important to Work With a Franchise Attorney
Even if you have extensive business experience, it’s always in your best interest to collaborate with a skilled attorney. Buying a franchise is a complex process that involves multiple decisions and lengthy contracts. To avoid future disputes that could be expensive to litigate, make sure you get legal guidance while you’re in the buying stage. When you need reliable legal support, the trusted franchise lawyers at Bundy & Fichter PLLC are here to help. From their firm in Seattle, Washington, they proudly serve clients throughout the country.
Get Knowledgeable Guidance
Bundy & Fichter PLLC offers over 50 years of combined experience in representing franchisees, franchisors, and small business owners. They are highly knowledgeable, and they deliver business counsel in accessible language so that you have the information you need to make your investment decisions with confidence. To get the support you deserve, reach out to their office in Seattle, Washington, today and schedule an initial consultation.