Tell-All

LANE FISHER

Franchisors in the heat of battle for qualified prospects are embracing more comprehensive financial disclosures about their models, in an attempt to differentiate themselves from competitors in a crowded space.

Before you blame sluggish sales on the franchise contract, or lack of access to credit, consider whether you are presenting your opportunity in the most favorable light to prospects. We are amazed by how often franchisors struggle with identifying their particular strengths or why their particular opportunity is right for current economic times.

I still hear people repeat stale advice from parochial legal counsel that Item 19 financial performance representations (FPRs) create liability for franchisors, and that a small percentage of franchisors use them. While the share of franchise brands providing FPRs increased from 38 percent in 2008 to 45 percent in 2012, this means nearly half of franchisors still don’t provide prospects with any financial performance information.

In practice, earnings claims actually mitigate liability by providing a context within which all oral representations can and should be measured, making it difficult for a prospective franchisee to claim that it was reasonable to rely on inflated oral representations from a franchisor when the registered FDD says otherwise.

As long as you document all your material assumptions, make all the required disclosures and maintain the required records (referred to as substantiating documentation by the FTC), you solve many more problems than you create. Moreover, while the total percentage of all franchisors making FPRs may not exceed 45 percent, that number approaches 100 percent when it comes to broker referral networks that are populated by rapidly growing brands. And, FPRs are pervasive in systems that target existing multi-unit franchisees.

These days you just can’t be competitive without one. I honestly feel sorry for a franchisor who is trying to compete with one of our brands’ FPRs.

Now, what do you say in the FPR? Most systems report gross sales, often broken down by size and type of unit, sometimes geographically and often stated in quartiles. It’s hard to attract existing multi-unit restaurant franchisees without publishing some information on at least the largest expense categories, such as food, labor and occupancy in a restaurant business.

But don’t stop there. In a restaurant, if you have a particularly productive catering or delivery operation, or branded product sales, or supply chain, inventory turnover, holiday promotion, loyalty program, customer tenure, frequency, or any measure of repeat business, customer satisfaction, community outreach program, multi-unit performance, accelerated ramp-up or just about anything else, say it.

With your desired metrics in mind, prepare a spreadsheet with all units, and organize similar units together (like pad sites or 1,500-foot units, etc.), so you can have smaller samples of more similar units. Now borrowing a methodology described by Cousins Subs, identify your highly efficient units apart from your sample, which I am going to bet represent your current configuration, design and would be similar to locations you would approve and award today.

I typically find a much narrower range of results for these units and believe the performance of these units is the most relevant information you can present to franchise prospects. As you look at outliers on the spreadsheet, obvious causes surface that you can document in the FPR and exclude from the sample (like a pure takeout restaurant, or unit open less than one year), trying again to prune the sample down to ones most like the units you are currently selling.

Beyond restaurants, mobile service businesses continually try to distinguish themselves from each other by showing things like closing rates of outside salespeople, productivity per vehicle, volume of leads through call centers, productivity of showroom, referral sources or marketing initiatives.

Other franchisors use FPRs to motivate other franchisees to voluntarily embrace certain activities, like using an outside salesperson, or upgrading equipment, or offering new services. Franchisors can also demonstrate how the products and services that initially drew customers to franchisees can be used to leverage up-sells in ancillary products or services.  If certain product lines are generating more growth than others, franchisors can separately disclose their various revenue streams and highlight those showing the most growth.

One thing’s for sure: This process should not occur in a vacuum. Attorneys or others preparing FPRs should meet with franchise salespeople to identify what fears prospects voice in the process, and then consider what information you can present to mitigate those fears. In businesses without a retail storefront, many fear they won’t get enough customers, or grossly overestimate the number of customers or transactions they will need to break even, or revenue potential per customer.

 For example, if your relationship with the ultimate consumer is on a month-to-month basis, but in practice customers stay with you for five or more years, you need to disclose it.  Going further, if your average product costs the customer $3, but your average ticket is $20, then you need to say it. If the actual average tenure of a student at your school, dance studio, karate school, sports camp or music school is long term, far exceeding the term of a customer contract, why would you hide it? If your national accounts program generates a particular volume of business for franchisees, without having to sell it, lead with it.

If you don’t have an Item 19 FPR, you are leaving opportunity on the table. If you want your salespeople to succeed, you need to arm them with the appropriate tools. So before your next FDD update, debrief your sales people about your prospects’ fears, and develop meaningful metrics to demonstrate your brand’s strength. Almost every brand that has undergone this process, and expounded upon their Item 19, has shortened their sales cycle and sold more units.

Attorney Lane Fisher of Fisher Zucker in Philadelphia represents more than 75 franchise brands. Reach him at 215-825-3100 or lfisher@fisherzucker.com.