On November 10, The Federal Trade Commission (FTC) hosted a workshop to discuss its 'Franchise Rule'
The workshop topics included representations made by the franchisor for financial performance, use of disclaimers, as well as the format of the disclosure document required by the Rule.
Vetted Biz Co-founder, Patrick Findaro, discusses potential impacts and recaps from the workshop.
Hey. This is Patrick Findaro, Co-Founder at Vetted Biz. I just wanted to give a little update on a virtual franchise rule workshop that was hosted by the FTC, the Federal Trade Commission, as there are some pretty interesting discussions that happened with some of the top franchise attorneys from across the U.S., including attorneys from Cozen O’Connor as well as Piper. And some of the interesting insights that we’ve seen was perhaps having a mandatory Item 19. So, you know, right now it’s not mandatory to disclose the sales and financial figures of franchises although many franchisors do elect to disclose the sales, gross profit, perhaps the net profit of their franchisees. This is a bit controversial because sometimes the recording period and what franchisees qualify for disclosure or not can be skewed to make the franchisor seem a lot better.
For example, we’ve reviewed franchise Item 19s where they only disclose the gross profit and sales of the top 25% of franchisees. And you think, you know, what about the other ones that aren’t disclosed there? We’ve also seen it where they only disclose finances on franchises that have been continually operating for a period over one year or a period over two years. So with that, you miss out a lot on the franchises that only have been operating for, you know, 6 months, 12 months. It’s really important to understand how those financials are. One thing that we have seen that is a bit troubling is the Item 19 that…oh, sorry, the Item 7 that shows the cost and the range to open a franchise and as well as item by item, including franchise fee, rent deposit, any permit costs, etc., it will give a low and a high range.
Oftentimes the working capital is for three months. However, talking to franchisors, talking to franchisees, it’s not just three months of breakeven. You need more working capital. So they’re understating the working capital. I think that’s a bigger issue that wasn’t discussed during the last virtual franchise rural workshop earlier this week on November 10th. There were a lot of items discussed in terms of requiring the Item 19. According to the FTC attorney, she says back in 2007, 20% of franchises disclosed in Item 19. The International Franchise Association estimates that at 66%. I had our researchers do a quick check. We’ve looked at 1,800 franchises over the last 2 years for their FDDs that they’ve released. Now, we only saw that 56% of franchises did actually disclose their financials via the Item 19.
You know, there was some discussion during the workshop in terms of requiring certain financials disclosed, such as sales or gross profit. I do think that makes a lot of sense because once you know the sales, then you can look at that industry to deduce a lot of the…basically the estimated profit and loss. And then also you have the royalties, which is a percentage of revenue generally, as well as the ad fund or marketing costs. So I thought that was an item that probably does make sense. Also in terms of, if there’s a broker involved, like a franchise broker or a franchise consultant, disclosing their fees. So it’s better for the consumer to know, you know, how much the franchise broker or consultant is getting paid. And, you know, I know there’s some franchisors that pay a ridiculous commission to franchise brokers and consultants. And, you know, if they’re receiving 15,000 versus 5,000 and they’re presenting multiple opportunities to a prospective franchisee, how is that going to, you know, influence the light and the analysis that they provide or the lack of analysis that they provide to the prospective franchisee?
A lot of these franchise consultant networks, it’s generally run like a real estate brokerage firm where you essentially have sales associates that they’re not doing really the research themselves, and they just have…they do all the marketing and sales, and they’re relying on the brokerage network to have 400 franchises that have favorable compensation for the franchise broker if they place a candidate. I know it from our time at Visa Franchise, looking into some of these networks, you know, with 400 franchises, there might only be 20 that pass our due diligence. So in terms of the brands these franchise brokers are representing, oftentimes they are swayed by having that heavy commission.
#FTC #Franchising #ITEM19 #Transparency #DataInvesting #Smallbizinvestor #PowertothePeople #Smallbizbuyer
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