Financial Performance Representations

by Nexsen Pruet, PLLC
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On Tuesday February 11th, the Charlotte Business Franchise Network met on the 15th floor conference room at Nexsen Pruet. The attendees, representing a broad cross section of franchisors, master franchisees, and franchise suppliers, were undaunted by the weather, and gathered to talk about Financial Performance Representations.
 
The discussion leader was Kevin Drudge, who is the vice president of franchise development for Advanta Clean. Kevin discussed with the group the value, importance and limitations of Financial Performance Representations ("FPR") found in item 19 of the Franchise Disclose Document ("FDD").
 
The group was reminded that FPR's are optional, and that while they are neither required, nor illegal as some franchise sellers thought, Kevin advised the group that franchisors benefit from providing them to their prospective franchisees because,

  • FPR's may be more consistent and reliable than having to obtain that information solely by speaking with existing franchisees in the franchise system
  • FPR's are a good source of protection against franchise sellers, including brokers, from making unauthorized FPR's

The group discussed what constituted an FPR. A FPR is:

  • Any representation, including any oral, written, or visual representation to a prospective franchisee, including a presentation in the general media that states, expressly or by implication, a specific level or range of actual sale, potential sales, income, gross profits or net profits.
  • FPRs are notes in charts, tables or mathematical calculations - - all of which may show possible results based on a combination of variables
  • Financial claims found in the General Media can be FPRs

The Federal Trade Commission Rule on Franchising ("FTC Rule") requires that anything considered to be a FPR must be disclosed in item 19 of the FDD. The failure to include FPR's in the FDD is a violation of the FTC Rule. Likewise, giving someone an FPR that is different than what is included in the FDD is a violation of the FTR Rule.
 
The group also discussed what is not a FPR. Generally speaking, a lists of costs and fees necessary to open and operate the franchise, which are usually found in items 6 and 7 of the FDD are not considered to be FPR's. However, providing a prospective franchisee with cost percentages of sales would be considered a FPR.
 
FPR's that appear in the General Media must refer back to the FPR's disclosed in the FDD and cannot vary from those disclosures. Financial information presented in the general media is considered to be an FPR if the information would tend to attract members of the public that are interested in purchasing a franchise. General Media includes:

  • TV
  • Radio 
  • Newspapers and magazines
  • Billboards
  • Electronic advertisements- especially those on a franchisor's website
  • Social media
  • Bulk mail (SPAM)

What is generally not considered to be the General Media for purposes of FPR's are:

  • General speeches or press releases about the franchisor- unless placed by the franchisor
  • Financial Information found in governmental filings like 10Q's and 10K's

FPR's may be presented as either historical or pro-forma financial information. In either case there must be a reasonable basis for the presentation of this financial information.
 
A reasonable basis is considered to be financial information that is based on:

  • Actual financial information collected by a representative sample of franchisees in the franchise system
  • Financial information collected by the franchisor in the operation of its company-owned units, provided that the use of that information is separated from the franchisee information and that it is presented as company unit owned results- with appropriate explanations on how the information would differ from a franchisee's operation of the same business.
  • The financial information presented must support the representation
  • The information must be of a type that a reasonable prospective franchisee would rely upon in making their decision to purchase a franchise.
  • When presenting the information it should be compared against results of a designated universe of franchisees in the franchise system.
  • Using quadrants or quartiles of results is the usual method of presenting FPR's in the FDD.

The group also discussed what would constitute an implied earnings claim, including the use of franchisee business plans that may be prepared before a franchisee signs their franchise agreement.

  • The group was cautioned that accepting a business plan from a franchisee before it signs the franchise agreement would be as much of an FPR as providing to the franchisee a pro-forma of the sales and expenses that a franchisee could realize in its business.

The last topic that the group discussed was the importance of making the underlying information forming the basis of the FPR available to the franchisee if requested.
 
In addition, if a franchisor seeks to sell one of its company-owned units then it could provide the prospective purchaser of that unit with specific financial information about that unit even if not part of its FPR found in its FDD, provided that such information was fairly presented.
 
 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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