How Much Can I Make?
Entrepreneur US|January - February 2023
It's what everybody wants to know before buying a franchise-and although there's no guaranteed answer, you can learn a lot by asking the right questions. Here's how.
By Mark Siebert

So you've decided to buy a franchise. You've done your research, and have narrowed it down to a short list of companies that excite you personally, are profitable, and have management teams you are willing to bank on. Still, you haven't answered the most important question: What can I earn? Obviously, the main reason most people buy franchises is to earn money, but no good franchisor would ever answer that question directly. They would have far too much liability if they did. A franchisor should instead provide you with some guidance to help you make that estimate for yourself. The key to making that calculation starts with something called the "financial performance representation," or FPR.

Where would you find the FPR? In many Franchise Disclosure Documents (FDDs), which a franchise will provide when you're considering becoming a franchisee, you will find the FPR in Item 19. Almost always, the FPR focuses on historical results that have been achieved by the franchisor, its affiliates, its franchisees, or some combination of the three. The FPR may come in the form of an income statement, but more often, it will focus on some of the key variables that will dictate income (and will enable you to develop a pro forma income statement based on those variables). The format and utility of these FPRS vary from franchisor to franchisor.

Be aware that franchisors are not required to provide their franchisees with an FPR. In the early days of franchising, the use of an FPR (then called an earnings claim) was more the exception than the rule. In fact, in the late 1980s and early 1990s, less than 20% of franchisors provided one. Many were reluctant to share this data out of fear that it would result in litigation and were often warned against it by their lawyers. But over the past few decades, there has been a strong reversal of opinion on FPRs; by most estimates, the majority of franchisors provide at least some information in Item 19. In a 2018 study that looked at 1,497 FDDs, Rob Bond, president of the World Franchising Network, found that 61% included some kind of FPR.

Why no FPR?

If a franchisor does not have an FPR, its absence will make it difficult for you to estimate your revenues and profits. And while the uncertainty of your projections will increase your risk, that does not necessarily mean you should immediately eliminate the franchise opportunity from consideration.

The (good and bad) reasons franchisors might not provide an FPR:

1/ The franchisor may believe the units it could use for an FPR are, for some reason, not typical of what a franchisee might expect to make. In fact, it may believe its own performance will be stronger than the performance of the franchisee and may have avoided the FPR in order to be more conservative. For example, perhaps a given franchisor has a unique location or has been in business for decades serving one community where the brand has become iconic. Perhaps the franchisor is franchising only part of its current operation, based on the belief that the franchisee needs to start with a less complicated business (perhaps evolving later to a fuller line of products or services).

2/ The franchisor may believe it will incur greater legal exposure by making an FPR (although this is probably not true, assuming the franchisor uses historical financial information as the basis for the FPR). Still, their attorneys may want the brand to approach the issue of financial disclosure with absolute, extreme caution.

3/ The franchisor may not want to disclose unit-level financial information out of fear that its competitors could use that information to their advantage.

4/ The franchisor (especially newer franchisors that have conducted most transactions at the unit level in cash) may historically have been understating its sales to the IRS to reduce its taxes, and now it cannot substantiate its actual levels of sales based on its own historical numbers.

5/ A new franchisor may not have an adequate operating history on which to base an FPR. For example, its locations may have been open less than a full year.

6/ The franchisor may have recently opened a new prototype that will be the basis for the franchise program, but it does not want to provide that information for fear of liability.

7/ The franchisor may fear that its historical financial performance does not compare favorably with its competitors.

Obviously, those last few reasons should be of some concern to you as a prospective franchisee, and you should add those questions to your list for further discussion with the franchisor if it does not provide an FPR.

But regardless of whether the franchisor supplies an FPR, your next job must be to develop an estimate of what you can expect to earn as a franchisee. This is your most important task before purchasing any franchise.

Use, but never rely exclusively on, an FPR.

When doing your WH research, nothing should make you happier than finding that a franchisor has provided an FPR. Generally, that means the company thinks it has something to brag about from a financial perspective. Moreover, it is making your job easier by telling you up front what kind of financial results some of the units in their system are achieving.

If a franchisor supplies an FPR, you should definitely use it as a starting point. Most FPRS will provide you with great information, and you (and your accountant) should read them very carefully to be sure you understand how to use them in your business planning.

However, as you go through this process, it's worth keeping this old saying top of mind: "There are three kinds of lies: lies, damned lies, and statistics." For example, there was one well-known franchisor that for years provided an FPR based exclusively on the performance of a handful of corporate locations. Those locations had far greater revenues and profits than the vast majority of franchisees in the system. But unless you read the footnotes closely, you might never know they were not a representative sample. While this kind of statistical juggling is no longer allowed under the new FPR rules, there are other methods (grouping by age, type of location, etc.) that could be used to give you unrealistic expectations (intentional or not).

Your first job, then, is to read the FPR thoroughly. Generally, it will have a load of disclaimers and footnotes. These are often as important as the financials themselves, so pay close attention. If, for example, the financials are based only on locations open longer than three years, you may want to ask yourself what the first two years looked like. If labor costs are reported, check whether those calculations include management as well as staff. Do some digging. And if you are not good with numbers, now is the time to get your accountant involved. (Either way, you will want them to look at your projections. More on that later.)

Also remember that no government agency has done any real due diligence on the document you are reading. It is up to you to be sure you are getting reliable information.

As you are reviewing the information in the FPR, note the format the franchisor uses to present the information. Franchisors in the same industry may present very similar information in slightly different formats-so carefully note those differences. As you may have noticed, there are hundreds of different ways in which earnings information can be presented.

Some franchisors include historical income statement-perhaps modified to incorporate line items for advertising fees, royalties, and other fees you may incur as a franchisee. These may be the best types of FPRS, as they allow you to compare the numbers you think you can earn with those that were historically achieved by the franchisor-but don't rely on them too heavily in your planning, as your market conditions may be different.

Other franchisors are somewhat less forthcoming with their numbers. Some may choose to only disclose sales numbers. Some may limit it to average selling prices, average sales per square foot, average sales per salesperson, or any of a variety of other indicators. Fitness clubs may be broken out by number of members. Automotive franchises may focus on the number of vehicles serviced per day.

Restaurants may show food and labor costs but not occupancy (as this is often best determined on a market-by-market basis). Hotels often include occupancy rates in their FPRS to enable you to project revenue based on the size of your facility.

If a franchisor does use a historical FPR, you can ask to see "written substantiation for the financial performance representation" and the franchisor must provide it. So if you are not clear how the numbers were derived, ask.

Don't do anything until you've crunched the numbers.

Regardless of whether the franchisor supplies an FPR, you must develop a pro forma statement of cash flows (which basically predicts how much revenue will come in and the expenses incurred during a given period, so you can understand your cash requirements and your profitability over time) for the franchise opportunity you are considering. In doing this, you should exclude some items you would normally find on an income statement, like depreciation, amortization, interest, and taxes, leaving you with a bottom line typically referred to as EBITDA (earnings before interest, taxes, depreciation, and amortization).

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