Evaluating Potential Earnings: Item 19 Q&A

Potential franchisees do their due diligence by asking franchisors questions, interviewing existing franchisees, and evaluating the franchisors’ Franchise Disclosure Document (FDD). Item 19 makes representations regarding earnings, so it’s an item of great importance in the evaluation process.

Since the introduction of Item 19, franchisors have more legal obligations to back up claims they make regarding the potential income of their franchisees. It has become a validator for the franchise brand and is a way that franchisors can boast about their earnings claims of their franchise operators.

According to franchise attorney and partner at Fisher Zucker LLC, Lane Fisher, Item 19, while bountiful for the people researching the franchises that catch their attention, is not and should not be the only means they learn of income potential.

Fisher is an advocate for franchisor transparency. Below, Fisher offers his perspective and advice on Item 19 and the additional investigation prospective franchisees should be conducting:

I’ve been a longtime believer in Item 19 financial performance representations and a proponent of their use for all our clients. Franchisors have to find a way to legally answer the one question every prospective franchisee wants to know: “how much can I make?” I think the old school thinking was that it was risky to present an earnings claim and expose the franchisor to liability if the franchisee didn’t perform as well. In my experience, and the case law bears this out, a well-crafted and compliant Item 19 is a shield for the franchisor.

Please provide some history into how Item 19 became so highly used in the FDD and in franchise development marketing?

Competitive pressures pushed franchisors to increasingly make financial performance representations in their FDDs. Especially as prospects compare multiple brands presented by brokers, providing meaningful information in Item 19 can be a tremendous competitive advantage, and the absence of one stands out as a negative.

An Item 19 both manages a prospect’s expectations and mitigates liability for making illegal earnings claims, because the Item 19 provides a barometer against which to measure any oral representations. In the face of a written Item 19, it’s simply not reasonable to rely on any inconsistent oral representations.

Franchisees should distinguish between statements of historical performance and projections, and almost never rely on the latter without further substantiation and validation in their respective market.

Franchisees should use Item 19 to learn how the business earns income and incurs expenses and then prepare detailed projections with the help of an accountant or lawyer. Often it is helpful to obtain and compare competitors Item 19s and to understand how the business models are distinguished. Many franchisor FDDs are available for free online in several registration states such as Minnesota and California.

It’s still voluntary, and franchisors are free to not make them or limit what they disclose, but it’s still a worthwhile exercise to see how competitors describe a similar business, while keeping in mind that it is a different business.

My advice to prospects trying to evaluate how much they can make is to study an Item 19 carefully, pay attention to exactly what’s being presented and, perhaps more importantly, what’s not being presented. Read the notes to the Item 19, not just the charts.

Franchisees should develop a list of questions and call as many franchisees in the system as possible and ask about their experience and financial performance, or at a minimum verify the information in the Item 19.

The rules surrounding how a franchisor presents data in an Item 19 is changing. The new rules will limit the use of data presented for only company or affiliate-owned units, and require franchisors to present more franchisee data if they use subsets or only profile higher performing units. From the prospect’s perspective, the advice will remain the same – pay attention to what’s actually presented, what’s not presented, and ask a lot of questions.