NASAA releases commentary proposing major changes to Item 19 Financial Performance Representations.
Oct 7, 2015
By Lane Fisher – FisherZucker Attorneys
On October 1, 2015, NASAA released a proposed commentary on financial performance representations that could dramatically affect the way franchisors disclosure financial performance in the FDD. There appears to be a rising tide among state examiners to require more complete data. Today, more and more state examiners require franchisors to add disclosures about company- or franchisee-owned units as a condition of registration. If adopted, franchisors would be prohibited from picking and choosing subsets of data to present in Item 19 as currently permitted, and will likely have to provide the same or similar data for a larger population of the franchise community or all units. Further, franchisors could not disclose the performance of the best performing units without disclosing the same metrics for the worst performing units.
Moreover, the commentary prohibits franchisors from creating an Item 19 based on company-owned performance without also making the similar disclosure for franchised units. If a franchisor doesn’t have any franchisees, then the franchisor is limited to providing only top line gross sales. For years, we have been recommending franchisors make cost disclosures as far down as they can go, to manage expectations and present a more robust set of data. This will make it more difficult for potential franchisees to understand these costs as they relate to gross revenue.
This commentary changes the level playing field. Maturing and emerging franchisors in the same industry will become harder to compare due to prohibitions on new franchisors disclosing cost information in any form, as well as prohibitions on the use of subsets for franchisors with less than 10 units, even if those units are substantially different. For the latter, the commentary requires disclosure of either all units or no units.
In light of the commentary, franchisors must practically reconcile a lot of cost information, or use a uniform chart of accounts. These practices will likely lead to more predictive benchmarking information on the backend. However, the commentary will also place pressure on risk adverse franchisors to completely remove their Item 19s. In doing so, this commentary could undermine its own goal, resulting in fewer disclosures all together rather than more transparent disclosures.
We urge you to read the commentary with an eye on how it may affect the way you currently prepare your Item 19. For those of you with less than 10 franchises, please consider how these new rules will significantly hinder your ability to grow and develop units. For those of you with robust financial performance representations, please consider how these rules will drown out your positive numbers with non-representative noise and slow your momentum.
An open comment period on the proposed commentary lasts until November 2, 2015. We will be commenting on the commentary ourselves, and we can help coordinate any comments you wish to send in opposition. Please reach out and take the time to address a crucial part of your franchise system. We are here to help.