No Financial Disclosures - The Excuse
“We cannot provide you with any financial results of our existing franchisees because the FTC and/or state law prohibits it.”
I can’t count how many times I’ve heard directly from franchisors that they choose not to disclose financial results or franchisees because they are prohibited by law. That is an outright lie, and at the very best, extraordinarily misleading. The FTC wants to encourage franchisors to provide as much financial guidance as possible, but that guidance must be delivered in a consistent and regulated manner so as not to mislead the potential franchisee.
On Michael Webster’s BizOp blog, he looks at Romp ‘n Rolls bogus claim that they do not provide the financial results of their franchisees because FTC prohibits it.
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Ryan, the new FTC Biz Op Rule goes so far as to deem this practice a violation of Section 5, that is a deemed misleading or deceptive practice.
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The excuse, “it’s against the law for me to disclose financial results” is one of franchising dirty little secrets. I call it the franchise “non-disclosure dance”.
True, it is against the law to state any financial information if it is not disclosed in item 19 of the Franchise Disclosure Document (FDD) (formerly the UFOC).
The reality is: it is not illegal to disclose financial information as long as it is disclosed in item 19 of the FDD. Sales people who are selling a franchise without a financial disclosure in item 19, are forced to do the “non-disclosure dance” around the fact that the franchise they are selling does not make a financial disclosure.
Given the fact that the sales person could be selling a franchise with an investment of $150K or more it seems ridiculous that they could expect someone to make that investment without some sort of financial disclosure up front, it must be against the law, right? It’s the only plausible reason, right? Wrong on both accounts!
The sales person is just trying to justify the lack of financial disclosure. That is what the “non-disclosure dance” is all about.
I am hopeful more and more franchisors will make financial disclosures in item 19 and make the “non-disclosure dance” a thing of the past.
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The recent posts regarding Quiznos are outline the plight of a franchisee in general. The present business model is based on system where the franchisor operational stucture eats up almost all of the store owners residual profits in round about deals with vendors required to maintain and operate the store–accounting services, pest control, towels and mats, paper goods, etc, etc. Some production costs may have recently been lowered a slightly, but mostly on cheaper items. Couponing has been reduced, but is still promoted on the company website. Meat, cheese, and most other ingredient costs have not been materially lowered; and there is always the lingering question of whether Quiznos Corporate–involved in the sale of food through its own Company–is a factor. The company has resisted creating a chain-wide food cooperative owned by the franchisees as now exists in Subway and some other brands. Recently the amount of meats on the sandwichs has been decreased to help with food costs. The popular prime rib sub involves expensive meat which reduces the franchisee’s profit margin. Prime rib tends to be fatty and shrinks when heated in a flavoring dip emphasizing the reduction in product weight at a time when customers seek added value. What happened to the advertising push against Subway about whose sandwich had the most meat? The old advertising promotion of “eat up” has now been effectively changed to “eat down” regarding product weight.
There is a new emphasis on inexpensive flatbread products to bring a new customer breed into stores, but cheaper products risk cannabilizing sales of traditional products. There is also now a mandate to deliver food as a way to increase sales, the idea being that online orderers are more likely to purchase add-ons. Unfortunately finding and hiring suitable drivers is not easy, and delivery puts huge risks on the owner in the way of liability for accidents, etc. Since many drivers are young, insurance costs are expensive. The profit margin in delivery is not high to increase the owners profit much above break-even. The franchisee must pay the company fees for using its internet ordering website and directs owners to vendors for new paper and other supply products involved in delivery. Remember those hidden vendor costs above. The equation is again shifted in the direction of the company. The franchisee’s profits are about break-even with greater work, addedcosts, and increased personal liability risk while the franchisor gets a biggest piece of the pie in royalities and advertising assessments.
Quiznos products are tastful and the brand will likely continue. But for the a brand to reward franchisees fairly a major shift will have to made whereby the franchisor treats the franchisee as a valued equity partner, not just a servant whose job is to feed the master. Things may be changing in the company however results have to be measured in increased average same store sales, real pocketable margin increases for store owners, and transparency in the company’s operation. Since the company is owned by a number of private equity firms operational openness may be at a distance.
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I certainly do not condone a franchisor knowingly misleading franchisees regarding the FTC’s disclosure guidelines but disclosing financial information in Item 19 is not as simple as reproducing statistics for potential franchisee consumption. I have represented franchisors that, with the assistance of counsel, have made a good-faith effort to honestly disclose information in Item 19 only to have a dissatisfied franchisee dissect the disclosure in search of a negligent or “intentional” misrepresentation. Unintentional omissions ranging from differing geographical markets, seasonal demand or the existence of a non-mandatory gift card program are just some examples of traps waiting for unsuspecting franchisors. If the franchisor fails to fully disclose variables applicable to the financial information provided there could be unforeseen legal complications. Some franchisors choose to make no disclosure and urge the candidate to speak directly to other franchisees. This does make for a bit of dance when sales representatives are asked direct questions about earnings and profitability but in many cases they are damned if they disclose and damned if they don’t. Generally speaking, I am in favor of a meaningful Item 19 disclosure but only after the franchisor has conferred with experienced franchise counsel and perhaps a litigator.
Christopher Brown
Quagliano & Seeger, P.C.
571-434-7590
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I think that one of the former ABA Chairmans of the Franchise Forum (Andy Selden?) indicated that it was “silly” to mandate 22 items of disclosure and not to mandate Item 19 disclossure, which is the most important “essential” information that should be disclosed to new buyers of franchises.
Only a very small percentage of franchisors disclose “earnings” information because, of course, they don’t have to under the provisions of the Rule, and this, together with confusing and imprecise Item 20, protects the franchisors 100% from any claims from franchisees that they have been fraudulently induced to contract by false claims of success, etc…
It almost looks like the UFOC (FDD) together with the boilerplate and non-negotiable and unilateral contract. that always that contains Acknowledgement and Reliance clauses wherein franchisees acknowledge that the franchisor hasn’t promised them either success or profits and that they haven’t relied on any information or promises that are not contained withing the four corners of the contract, was designed to give franchisors immunity and impunity under the law to sell their franchises without disclosing the material risk factor of past or present performance statistics on a unit basis to new buyers of their franchises.
I have never been able to understand why the FTC has permitted the franchisors to avoid disclosure through the artifice of Item 20. The franchisor is the seller and it the seller who should disclose risk and reward to the new buyer and not the current and past franchisees who have no legal obligation to disclose to potential buyers of the franchise. Obviously, anything these franchisee references say has no legal significance, and if they make mistatements, etc.., any damages that a potential buyer may suffer after signing the franchise agreement are proximate to their misrepresentations and NOT tol the franchnisor’s misrepresentations.
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P.S. The artifice of the FTC is shameful. They license the franchisors NOT to disclose earnings on a unit basis and NOT to disclose unit performance statistics to new buyers of franchises, and then try to make themselves look good by indicating to new buyers that the FTC doesn’t prohibit franchisors from making earnings claims.
And these people are on the public payroll? We need TRUTH IN FRANCHISING. As Susan Kezios of the AFA indicates, the FTC took ten years to produce a mouse that in reality is a rat in terms of the damage that the Rule and the UFOC’s do to prospective franchisees
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