Why Your Item 19 Sucks

How to Craft a Franchise Earnings Claim That’s Accurate, Precise, and — most importantly, Tells an Engaging Story

Item19(B)Franchise Attorney’s conventional thinking about item 19 earnings claims has been relatively stagnant over the last 20 years. Thinking has evolved, but slooooowly. It went something like this:

1990: Franchise Sales Person: “Can we do an earnings claim?”

Attorney: “No. We will get sued.  Now get out.”

1995: Franchise Sales Person: “Can we do an earnings claim?”

Attorney, “What part of ‘No’ don’t you understand? We will get sued.  Take a hike.”

2000: Franchise Salesperson: “Can we do an earnings claim?”

Attorney: “Let me think about it. No. We will get sued.  Beat it.”

2005: Franchise Salesperson: “Can we do an earnings claim?”

Attorney: “Yes. The average sales volume is $X, but past performance in no indicator of future results. Your results will vary depending on the quality of real estate, transferable skills, experience, capitalization, whether or not you attended public schools, have lingering psychological issues resulting from inconsistent potty training, and whether or not you are dumber than a box of rocks.”

2010: Franchise Salesperson, “Can we do an earnings claim?”

Attorney: “Yes and it could be safe to use it on your website and in your marketing but let’s see what other companies do and how often they get sued before we try it.”

Among smart franchisors, the conversation shifted from “Should we or shouldn’t we?” to “How do we tell the best story possible?”

2013: Franchise Salesperson: “Can we do a Financial Performance Representation?”

Attorney: “Yes. First let me apologize for all the hard times I have given you over the last 20 years. Let’s sit down and discuss what issues and questions a candidate has and how we can best use our financial data to satisfy these concerns and move them forward in the process, just like you’ve wanted for more than two decades. Can you find in your heart to ever forgive me?”

Franchise Salesperson: “No.  Give me what I want and then go play in traffic.”

How Much Can I Make? – Now the most important question potential candidates want answered

Largely, an Item 19 Financial Performance Representation (FPR) needs to address basic concerns a candidate has early in the process, such as:

1. Is the business profitable?

2. How quickly does it ramp up?  When can I stop feeding the machine and start taking money out?

3. Is the business sustainable?  Will it continue to make money into the foreseeable future?

On one hand, Mr. Unhelpful Franchise Attorney of 2005, Esq. is right: A franchisee’s success may depend on such factors such as the quality of their location, the health of the economy, whether they are smarter than an eggplant, and whether they get hit by a Greyhound bus the day after tomorrow. But the overwhelming majority of candidates who are significantly more savvy than garden vegetables (even the formidable aforementioned Solanum melongena … look it up) will want to drill down into your data as much as possible in order to get the best possible answer to the questions “how much can I make?” and “What can I count on the business for?”

Before you craft you item 19, Ask yourself? What’s the purpose of an Item 19?

Look at your business from the candidates perspective.  What do they need to know?  What questions do they have?  What are their biggest concerns?

And as long as the information is historically accurate and representative of the chain, Lane Fisher, a trailblazing franchise attorney who represents more than 75 franchises, says that in his experience, there is little legal risk.

He believes there’s more danger for franchisors who avoid making robust financial performance representations. In the absence of an item 19, Fisher believes some sales people bob and weave around that question, and look for alternative ways to provide something resembling an answer. In the process, they frustrate the heck of out candidates who just want a straight-forward answer — and sometimes spill details and data that amount to a de facto illegal earnings claim, paving the way to potential future litigation.

Franchise candidates look to the Item 19 because they want to paint a picture in their minds of how they might perform as an owner in your franchise system. So, the top 20% of your stores have gross sales of $X, and the system-wide average revenue is $X. That’s nice to know, but it doesn’t tell a candidate much. If I’m a high-school teacher considering opening a franchise in Buffalo, N.Y.; I want to know what average gross revenue is in mid-sized cities; what average gross revenues are for franchisees with a teaching background; what average revenues are in Year 1, Year 2, and Year 3; the average length of time it takes to reach break-even; average labor costs in New York; and average revenue at locations in upstate New York.

Absent any data, a candidate is usually going to imagine the worst — I’m going to hand over my life savings, fail miserably, and wind up living in my mother’s basement. Or perhaps go into business with unrealistic expectations which were never properly managed. Count on this franchisee to harpoon future deals and kill off your growth.

Providing more data about franchise performance allows your sales team to help franchisees more accurately understand the opportunity.

Why Most Earnings Claims Suck

The vast majority of established franchisors now offer Item 19 financial performance representations (finally!), but most are still taking a very conservative approach in terms of the data they make available to candidates. A typical Item 19 might disclose average revenue, and break down performance into quintiles (average revenue for Top 20%, Top 40%, Top 60%, Top 80%, all stores).

If a franchise has been in business long enough that it’s shifted its business model, a savvy franchisor may craft an Item 19 that draws its data only from existing stores that closely resemble the current business model being offered to candidates. For instance, if your business originally targeted mall kiosk locations, but now looks for standalone retail spaces of approximately 1,200 square feet, it doesn’t make sense to provide data on mall kiosk performance to franchise candidates. Or perhaps the business has a new merchandising strategy, menu items, or décor package. Instead, the franchisor might draw its Item 19 data from the new strategy or model. That’s a step in the right direction, Fisher says. The important thing is that your criteria is consistent, and that your reasons for excluding some franchise locations from the earnings claim data are based on sound, defensible logic. As with any Item 19 earnings claim, you’ll need to maintain data records as well as a record of the logic that went into how you crafted your claim.

But to truly unleash the power of your Item 19 earning claims, franchisors should look deeper — and they should begin by gathering their sales team together to answer a basic question: What anxieties do candidates have?

Are people worried about ramp-up time? Are they worried about conversion rates? Are they worried about their personal sales skills? Are they eager to know how absentee-owner units perform? Are they worried about how their experience as a mid-level manager in a customer service call center will match up against the demands of their new business?

A great Item 19 will answer some of these questions. If your candidates are worried about their sales skills, you can craft an Item 19 that talks about your company’s booking rate, how much revenue comes from national accounts, and the rate of repeat business. Oh, $X a month will come to me directly from my franchisor’s national sales efforts, 2-out-of-3 people who call me will hire me, and customers come back 87% of the time? Suddenly, I’m not so worried!

Maybe your candidates are worried about how long it will take for the business to generate a replacement salary. A franchise performance representation can be crafted that shows when the average franchise reaches its break-even point, and the pace at which it begins generating growing gross profits.

Your financial performance representations should be designed to provide accurate information that meets your candidates’ anxieties head-on, and provides helpful answers which keep them engaged in the process. They should help tell a story about how your business is unique, profitable, and sustainable for the long haul.

How to suck even less: start offering supplemental FPRs

A well-crafted Item 19 can help answer a lot of general questions, but what about specifics? What if a CPA wants to know how other CPAs have performed or a professional salesperson wants to know how other professional salespeople have performed relative to the norm?

Can you provide that answer? Of course you can, you’re probably telling yourself! I’ll just give them a list of franchisees who have similar backgrounds, and let them call and get the great answers they’re looking for!

Software companies have a saying, “GIGO. Garbage in, garbage out.”  Meaning “bad input, bad output.” Franchise salespeople also have a saying, “Ask a bad question, you get a bad answer.”  A robust item 19 eliminates a lot of bad candidate questions.

For instance, one of my past franchise candidates once asked a mature franchisee, “What profits are you making?”

And she accurately answered, “We aren’t making any profits.”  She was a high volume store which generated great cash flow, but no profits, meaning no additional taxable income. She financed the store 100% and was retiring the debt with discretionary cash flow. She paid herself and her husband a salary and the business paid for the automobiles, cell phones, and other expenses which would otherwise be personal expenses.

The franchise candidate however interpreted her answer as, “She has been in business 3 years and made no money yet. She is failing…”  I couldn’t move him off this position. We lost what would have been a good franchisee to a false narrative created by a bad question coupled with an unhelpful answer.

Supplemental financial performance representations can eliminate a lot of similar types of confusion, build trust, and help candidates craft a story that’s more likely to reflect their experience as a future franchise owner.

Help franchise candidates build their own narrative

Zig Ziglar once said “People don’t buy drills, they buy holes.” But I’d like to expand on that idea. I don’t think people buy holes, either. They buy their own story about how their situation will improve by drilling a hole.

Carrying this logic into franchising, candidates don’t invest in franchises.  They invest in their story about how their lives and careers will improve as a result of being a franchisee. They buy a story about what it would look like to achieve whatever their definition of success.

Supplemental financial performance representations are tools that dispel misinformation and put dreams in sharper focus. As long as you use the same criteria for supplemental FPRs that you used in your main Item 19, there’s no reason not to break out a subset of franchisees and provide FPRs that show how similar franchisees have performed in mid-sized cities, or in a given state, or among franchisees with backgrounds in restaurant management, sales, car repair, teaching, public accounting, etc. If a franchise candidate has concerns about the ability of accountants to generate sales, why not show the candidate how other accountants have performed? If your candidate wants to open a store in the Southeast, and that’s one of your strongest regions, why not provide a supplemental FPR showing just how strong your franchise performance has been in that region?

Won’t that get you in trouble? Not if you do it right, Lane Fisher says. Remember, the goal of a supplemental FPR isn’t to massage the data in order to make things look better — it’s to provide the most relevant data which best addresses a particular franchisee’s needs and concerns.

Start thinking of your item 19 as your most powerful marketing tool. Properly crafted, an item 19 should help you recruit better qualified candidates and should create ways to make your franchise lead generation much more substantial. Think outside the box – or outside your FDD. The item 19 belongs on your website, on your portal pages and in your marketing. It, like its brother, the item 7, are the two FDD sections candidates most want access to BEFORE they talk to a recruiter.

If you use the exact same methodology when creating your supplemental FPRs that you did when creating the one in your Item 19, then you’ll be on solid legal ground. You’ll also be providing a valuable service — not just to your franchise sales team — but to franchise candidates.