If you are considering a large financial move, you already know it is vitally important to carefully consider all the documents that come along with it. All documents in these instances should be carefully scrutinized, by yourself and, if necessary, someone more familiar with legal, contractual agreements. In the case of a franchise purchase, one of the important documents is the Franchise Disclosure Document. Today, we will explore one part of this vitally important paperwork: Item 19.
Item 19 is the franchise earnings disclosure section of a document and you’ll need to study it carefully before you make the final decision to buy a business franchise.
So here’s an introduction to the Franchise Disclosure Document, or FDD, and a basic understanding of Item 19 in this important report. But start with some basic knowledge of the franchise model and why it might be an ideal match for your entrepreneurial mindset.
Why You Might Consider a Franchise in the First Place
As an entrepreneur, you might be seriously thinking about starting your own business from the ground up — and you might be hugely successful at it. There will be obstacles, as well as advantages, in front of you.
If you’re a first-time business owner, you might have to learn by trial and error, and that can get pretty expensive. You’ll have to attract clients or customers, even though they’ll have no familiarity whatsoever with your products or services or even your company name.
If you instead buy a franchise with high name recognition and respected brands, you’ll have a built-in customer base from the first day you launch. With the proper organization, you’ll have a proven track record to follow, and learn how to run your business in a way that has worked for the corporation and perhaps hundreds or even thousands of other franchisees within that system.
But before you seriously consider purchasing within any fast-growing franchise organization, you’ll want to know all you can about the corporation, the financial performance of its franchise system, and the path you’ll likely be able to take to entrepreneurial success. That’s where the company’s FDD and its Item 19 come into play.
Franchise Disclosure Document (FDD) Overview
The Federal Trade Commission (FTC) mandates that every franchise enterprise, or franchisor, must make an FDD available at least 14 days before interested parties sign a franchise agreement or pay any fees. The purpose of the FDD is to put all relevant and important information about the franchise and the offer in writing so it can be thoroughly reviewed and analyzed by prospective buyers and their financial team before signing paperwork to purchase franchise locations.
The FDD is a prospectus that outlines the business model and the franchisor’s operations. It discloses past and current lawsuits, financial history, the various costs associated with franchise ownerships, and the expectations and obligations of both the franchisor and franchisees, among other pertinent data.
What Is the FDD Item 19?
The item 19 is a section of the FDD that spells out the Financial Performance Representations, or FPRs, of the company’s franchise system. This is a detailed accounting of such critical data points as franchisees’ gross sales, operating costs, profit margins, and related metrics to help entrepreneurs and their team of advisors assess the viability of franchise ownership. This section is often the most closely scrutinized part of the franchisor’s FDD — and for good reason.
Read on for a more comprehensive breakdown of the type of metrics that an Item 19 might include.
While the FDD Item 19 is not a mandatory section of any franchisor’s FDD, it is very often included. As a prospective buyer of a franchise, it’s understandable if you’d avoid taking a closer look at any franchise operation that neglected to make such critical content available. You want the best shot at success before entering into an investment, and the FDD can help shed light on your chances of succeeding.
Why an Item 19 Is Crucial for Franchise Buyers
It’s the full story in writing. It’s the facts, figures, and bottom-line metrics about the company you’re considering becoming involved with. Item 19 lays out what you might expect based on the experiences of other franchisees.
You should be able to use the contents of Item 19 of the agreement to help you make a realistic assessment of the financial performance you might expect if you go forward with a franchise purchase.
In addition, a well-written and comprehensive Item 19 might be important to a prospective lender and potential partners or investors. The more clearly they can see what they are getting involved with, the more likely they are to assist you in your venture.
Breakdown of What’s Typically Included, and How to Read Item 19 Data
There’s no standard format, structure, or list of information that must be provided in an Item 19, but these data points are commonly included in many FDD Item 19 write-ups.
Average Gross Sales or Revenue
This portion describes how much revenue comes in the door through sales, whether in the form of ecommerce, walk-in retail trade, or outbound sales channels.
Median Earnings
This represents the middle ground in profits generated by the company’s franchisees. Keep in mind, median means the data point that’s at the halfway mark of a ranked listing. When considering earnings, it means that half of franchisees generate more earnings than this number, and the other half earn less.
EBITDA
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. This is another metric for measuring the franchisees’ typical earnings, but not their actual income.
Net Profit
This is a financial performance metric that states the franchisees’ earnings after all expenses, including EBITDA, have been deducted.
Cost of Goods Sold
This is a critical metric to indicate the cost to the franchisee of the products it will sell to customers. This is particularly important to a startup if the new franchisee must buy a full opening inventory of products at one time. It gives you an idea of how much money you need to get the business off the ground.
Franchise Operating Costs
What does it cost to run the business on a day-to-day basis? This cost entry can include building rent, utilities, workforce expenses, inventory, supplies, and other required items and services.
Number (or Percentage) of Franchisees Represented in the Calculations
This is a disclosure of the basis for accumulating the data in Item 19. How many franchisees are included in the roundup?
Some Item 19 reports won’t include all of the above information, while others might provide even more accounting metrics. If you, or your financial advisors, don’t see the information needed to make a purchase decision, feel free to ask the franchise representative for the information you still need.
How to Interpret the Numbers Correctly
Pay careful attention to the language used in the document. Figures stated as “averages” will, of course, yield different results than “median” figures. Average figures can be misleading if there are relatively few locations in the mix and one of those is a high-volume location. For instance, you’d expect gross sales at a midtown Manhattan franchise with high walk-in traffic to be much higher than those of a location in a small town outside of Topeka, Kansas.
If the franchisor has only included their most successful franchisees, this will likely skew the results. That’s why it’s important to know how many franchisees were included in the calculations. The more they add to the mix, the more trustworthy the numbers.
Also, don’t miss carefully reviewing all footnotes, disclaimers, and other sources of small print. And never sign a contract without first having all of your questions answered to your satisfaction, as well as that of your legal and financial advisors.
Red Flags to Watch Out for in Item 19 Reports
As stated earlier, the absence of Item 19 disclosures should, in itself, be a red flag. Why is the franchisor not forthcoming with this important data?
But even if you have Item 19 content in the FDD you’re reviewing, watch out for numbers that look cherry-picked, or if the franchisor is vague on which franchisees were involved in the calculations. A small sample size can result in either deliberately or accidentally misleading data.
Also, be on the lookout for numbers that don’t make sense to your accountant and don’t become clearer after consulting with the franchise rep.
Your FDD on the whole, and the Item 19 section in particular, should be concise, comprehensive, candid, and clear. If the information you receive creates more questions than answers about the enterprise, consider continuing your search for the ideal franchise partner.
You’ll Always Receive a Well-Written Item 19 When Considering a Freeway Insurance Franchise
Now that you know more about analyzing franchise FDD Item 19 data, you can put your knowledge to good use. Start to explore the most lucrative franchise opportunities. We hope you check out Freeway Insurance, and think you’ll be glad you did.
Yes, our FDD includes an Item 19 section, and one that’s concise, comprehensive, candid, and clear. We know how important accurate financial performance information is to our prospective franchisees.
Freeway Insurance is one of America’s largest and most respected personal lines insurers. We’ve recently opened several franchise locations, and still have franchise-ready markets all over the country. We’d love to have you seriously consider joining us.
In addition to the strength of the Freeway Insurance brand, we offer a top-tier training program before you launch your franchise, and ongoing support as you need it throughout your career with us. We’ll even help you identify and acquire the licensing you’ll need to operate in your state.
You can start a Freeway Insurance franchise very affordably. You can work solo as an owner/operator until your level of success necessitates a larger workforce.
So let’s talk franchising. Just call one of our Freeway franchise representatives at 877-822-3024.
You can also give us your contact information, and we’ll take the first step.
