Franchise disclosure document
FDD / FTC Franchise Rule disclosure / Item 19 financial performance representation
A franchise disclosure document is the 23-item document a franchisor must give a prospective buyer under the FTC Franchise Rule, at least 14 calendar days before any binding agreement or payment. It sets out the costs, litigation, owner turnover and any earnings claims that a decision to buy a franchise rests on.
The Federal Trade Commission's Franchise Rule, at 16 CFR part 436, treats a late document as an unfair or deceptive practice. The franchisor must furnish its current disclosure document at least 14 calendar days before the buyer signs a binding agreement or pays it or an affiliate anything. If the franchisor alone makes material changes to the attached agreements, the buyer gets the revised copy at least seven calendar days before signing. Changes the buyer negotiated do not trigger that period.
Item 19 is the only place a franchisor may put a claim about sales, income or profit, and including one is optional. A franchisor that makes no claim must say so, and tell buyers to report other earnings figures to its management, the FTC and state regulators. A franchisor that does make a claim needs a reasonable basis and written substantiation, which it must make available on reasonable request.
For that claim, Item 19 must state how many outlets existed, how many supplied data, and the number and percent that reached or beat it. The FTC warns that a few very successful franchises can inflate an average. An outlet with high gross sales can still lose money on rent and overhead.
Item 20 lists current franchisees with outlet phone numbers, or at least those in the buyer's state and nearby states. It also lists every franchisee who left the system in the most recently completed fiscal year. If franchisees signed confidentiality clauses in the last three fiscal years, the document must warn that some may not be able to talk. Item 7 totals the estimated initial investment, including additional funds for an initial period of at least three months or a reasonable period for the industry.
Some sales fall outside the rule. One exemption covers deals where required payments to the franchisor or an affiliate, from before opening through the first six months, total less than $735. Another covers an initial investment of at least $1,469,600, excluding franchisor financing and unimproved land, when the buyer signs an acknowledgment. The FTC adjusts both figures every fourth year using the Consumer Price Index.
In practice
A buyer reads an Item 19 claim of $400,000 in average yearly sales per outlet. The notes beneath it show 120 outlets in the period, data from 100 of them, and 38, or 38%, at or above that figure. Item 7 puts the initial investment at $250,000 to $410,000, and the 14 calendar days give the buyer time to call former franchisees from Item 20 before paying a deposit. The figures are a worked example.
Why it matters to you
A franchise agreement can run as long as 20 years, and the FTC says any claim about sales, income or profits must be in Item 19. An earnings figure from a salesperson or broker that is missing from Item 19 is a warning sign. Some franchisors ask the buyer to sign a questionnaire about earnings claims before closing. The FTC says leaving out a claim that was made may waive the right to contest it later.
What to ask or check
- 01Did your copy of the disclosure document arrive at least 14 calendar days before anything was signed or paid?
- 02Does Item 19 show how many outlets supplied the data behind your earnings figure, and what percent reached it?
- 03What do the former franchisees listed in Item 20 tell you when you call them?
- 04Does the sale fall under an exemption, and have you been asked to sign an acknowledgment saying so?
What people get wrong
That every franchisor has to disclose what its franchisees earn. Item 19 is optional, and a franchisor that makes no earnings claim must say so and tell buyers to report any figures they are given outside the document.
Red flags
- A salesperson or franchise broker quoting sales or income figures that do not appear in Item 19.
- A request to sign an agreement or pay a deposit before the document has been in hand for 14 calendar days.