Let’s say you are considering the purchase of a franchise. During the investigation process, you ask the franchisor ‘How much money can I make?’ They respond with ‘We can’t tell you.’ Are they lying?
Not exactly… for two primary reasons. The first takes some understanding of history. The early history of franchise sales in the United States contained many instances of abuse when unjustified or misleading earnings claims were used to sell franchises. In 1979 the Congress passed legislation authorizing the Federal Trade Commission (F.T.C.) to regulate the franchise industry to try to stop such bad practices.
The current F.T.C. rules do not forbid a franchise company from supplying information about the earnings that can be achieved in their business. They do, however, have stringent rules on how this information can be given to a prospective franchisee.
This is one of the primary challenges of investigating most franchises. You’re not about to, nor should you ever, invest in a franchise until you know how much the business is earning and the ranges earned. The franchisor has all of this data, but about half of all franchisors do not share any information on earnings potential. Why is that? Because half of the franchise lawyers say it creates undue risk and liability. If you do not meet the numbers that are shared, it certainly opens the doors to future litigation. If it were up to me, I would make every franchisor share every P&L on every franchisee, but sadly I am not in charge.
But don’t get discouraged. Just because the information is not shared in 50% of the Franchise Disclosure Documents does not mean you can’t and won’t get your hands around this key earnings question. In reality, you would rather learn earning potential from existing franchisees anyway, right?!
Basically, any franchise that wants to provide this information must put it in writing in Item 19 of their Franchise Disclosure Document. It is essential for the franchisor to make sure that the data provided is as accurate and non-misleading as possible and they need to clearly label any assumptions or qualifications on the data provided. They are never allowed to make earnings claims that are not listed in the Item 19 of the Document. So if the franchisor says it is illegal for them to share earnings information, what they really should say is ‘we do not make any earnings claims in our Item 19, so therefore it would be illegal for me to share that information with you.’ Make sense?
Assuming the information is accurate and clearly labeled, they are free to provide whatever earnings information they want to a perspective franchisee in terms of sales, expenses, cash flow and income. Since it’s that easy, it begs the question of why more franchisors don’t do it.
The answer is twofold. First, producing financial performance representations does involve effort and expense for the franchisor. Second, the results (given that they must be accurate and non-misleading) may not be attractive enough to assist in the recruiting of new franchisees. If that’s the case, having the F.T.C. to hide behind gives a ready excuse to keep this accurate data from prospective franchisees.
If a franchise does not provide financial performance representations in their FDD, the best source of information to find out how much money you can make is the existing franchisees. The process to obtain an accurate understanding of the financial potential is laid out in The Franchisee Playbook. The chapters on understanding franchise earnings potential is shared under Insider Access. Go to the home page of my website to access. If you do not have the password to this section of my website, please feel free to call me at 443.977.8550 and I am happy to share access.
Once you have an idea of the ranges of earnings for a franchise, your next question will be what is a reasonable level of earnings for a franchise business. I think most experts would answer this question relative to the amount of the total investment required by the franchise. Though this is often not the case in franchising, you would probably expect the income to increase as the investment required by the franchise increases. Yet that is not always the case.
A good rule of thumb is that you can earn 10% to 15% on your money over time in a passive investment. Since most franchises require that you invest your time as well as your money, you should expect a return significantly higher than this level to justify the investment. This higher return will also offset the higher risk involved in this type of investment. You should look for earnings of at least 30% of your total investment on an annual basis to consider any franchise as having a reasonable return. You should expect to reach this level, at the latest, by the third year of operation of the business.
