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Guest post by: Mike Callahan Become an Author

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How much will I make if I buy this franchise?

This is a question that we hear frequently and I feel certain all franchise consultants hear it as well. It is a good question, but the answer is not that simple. It is important to understand that franchise companies are not being difficult or evasive; they have to play by the rules. In this fourth article in our continuing series we will give this question thorough coverage.
Like many good questions, the answer requires some background and that is where we are going to start with this.

A history lesson, pay attention, there may be a test.

To fully appreciate and understand the current state of franchising, it is important to understand the history of the business model that we call ‘franchising’. Let’s go back, way back. Our term for franchising is taken from a French term “francis” which means granting rights or power to a third party, originally this would have been a peasant or serf in feudal times. This all goes back to Europe and the feudal lords which puts us back in the mid-1600’s, but don’t panic yet we are going to arrive in the US soon. History gives us an idea that the concept and intent of what we recognize as ‘franchising’ today has been around for hundreds of years. Like any practice that has survived over hundreds of years of human history, it has changed/improved along the way.
So, that takes us from the 1600’s in Europe and now fast forward to the 1950’s in these good old United States of America. In 1950, best statistics say there were less than 100 franchising companies in the US. By 1960 that number had mushroomed to more than 900 franchise companies supporting more than 200,000 outlets. During this time there was no specified state or federal legislation governing franchising so as one might guess, unscrupulous players jumped in and nearly caused the concept to implode.

Franchising had such a bad reputation in those days the concept almost collapsed in the 1970’s and likely would have were it not for the government watch dog groups. These groups were lobbying for legislation to protect consumers for this business concept and their efforts were recognized, first at state levels and then the federal government stepped in.

California became the first state to regulate the sale of franchises when it enacted the California Franchise Investment Law (CFIL) in 1970. In 1971, annual retail sales of franchised businesses were estimated at over $114 billion. -- Between 1969 and 1973, an additional 50,000 franchised units took form, and by 1973, franchised businesses exceeded 374,000 units. The model was growing and state governments and the federal government were taking notice.

In 1978, the Federal Trade Commission (FTC) adopted the FTC Rule involving pre-sale disclosures, which became effective in 1979. This new act required exacting and specific disclosures from franchise companies. Now the disclosures would be the same format and highly regulated. Any claim in earnings had to be supported with valid documentation supplied by the franchise companies and subject to audit by the FTC. The primary piece of this legislation led to the advent of the Uniform Franchise Offering Circular or the UFOC. This was the disclosure document required in every state and several states had and still have additional requirements as well. For the first time, franchising was regulated by a government oversight department and once again the concept was in a strong growth pattern. In 1979, retail sales of franchises exceeded $274 billion, an increase of 140% from 1971.

In January 2007 the FTC introduced their newest regulation regarding the Uniform Franchise Offering Circular, or UFOC. The UFOC had been used in most states since 1978 but is now renewed and replaced with the newly named Federal Disclosure Document or FDD as it is called, effective July 2008. There are modest differences, but the core benefits and disclosures remain the same. The FDD is designed to protect citizens from un-substantiated claims and put everyone on a level playing field by disclosing the exact same information to any and all potential franchisees.

The FDD (currently in place in most franchise companies) has become the gold standard for franchisors and there are rules that cannot be ignored. In fact, franchisors are required to submit their FDD’s to the Federal Trade Commission for their approval prior to use. The FTC is charged with reviewing the documents as well as the supporting data supplied by the franchisors to validate any claims made. This practice does not preclude a franchisor from making earnings claims, but it does restrict what and how it is said. In fact, current estimates suggest that only about 25% (approximately 7-800) of the current 3,000 franchise companies disclose this information. If the company does include any statements about earnings they will be in their Item 19 section of their FDD.

Many companies do not make claims because they are restricted as to what they can and cannot say. What can be said can also be very costly to track and disclose and put into print. Perhaps the franchise company is emerging and does not have several years of data that would be helpful at this time? Or perhaps the company has changed their business concept/model and previous information is not relevant to the current structure? There are many reasons a franchise company would choose not to publish this and most of the reasons are protective and not elusive.

OK, so now what am I supposed to do?

All is not lost, not by a long shot. One of the very distinct advantages in considering a franchise opportunity is this: as a qualified ‘potential’ franchisee, you would have access to the company’s FDD. In the FDD franchise companies are required to list active franchise owners. You are free (and highly encouraged) to contact several of the existing franchisees and ask them whatever you like. Try doing that with your neighborhood dry cleaner competitor when you decide to open one.

Talking with existing franchisees that are doing what you are considering right now will be a fount of information. They have been in your shoes. They can (and most assuredly will) answer your questions with candor and based on actual experience. How can you improve on that; actual data straight from the source without editing?

Words of Wisdom in closing

If you find yourself considering a franchisor that does not offer claims in their Item 19 do not be unduly concerned. As part of your due diligence process you will be speaking to current franchisees and they will give ideas, thoughts and answers that you probably have not even considered. As a potential franchisee you are more like a partner than a competitor. You are considering joining a fraternity (or sorority if you like) of sorts. There are probably no secret handshakes but there is a level of frankness and honesty in your discussions that you will likely not find elsewhere.

Please join us in our next article when we discuss what information is in the FDD and what it means.

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