What is an Item 19?
If you’ve never explored franchising, you probably have no idea what I’m referring to here. “Item 19” is one of 23 sections provided in a Franchise Disclosure Document or (FDD). It’s an important item which prompts me to dedicate this post to it’s purpose. In short, it is a representation of financial performance of the franchise. As part of a franchisee’s due-diligence, they will review the FDD paying special attention to Item 19.
Why is it important?
People want to know if investing in this franchise will make them money! As a franchise broker, I talk to people about the kind of business they are looking for and why. The common answer is, “I want a business that makes money, because I need to make money”. Well, OK, that is usually a given, and understandably so. Nobody wants to make an investment in anything unless they are somewhat assured of a positive return. But unfortunately, I do not have the privilege to talk to my candidates about potential earnings of any given franchise. Why? Because it can form false expectations for the franchisee candidate and put the franchisor in a liable position. There are so many factors dependent on the success of a business:
- location of the business and the demographics
- the skillset of the owner
- the management of the staff
- the quality of the staff
- the training
- the economic climate
- the ability to keep up with trends
As you can see, no franchisor can know for sure about the success an individual franchise location, but for franchisors with years of experience and/or success, some are willing to provide some sort of guidance in Item 19 of the FDD. As a potential franchisee, you could have an advantage when considering a franchise with financial data in their item 19.
What is required in an item 19?
Although an item 19 “section” is required in an FDD, a franchisor is not obligated to include actual or potential financial performance of its franchised outlets. A franchisor is permitted to include financial data, but it is not mandatory.
When a franchisor does include this information, it can be stated in all sorts of formats. They have varying degrees of detail and can include different timelines of earnings or profits. In general, an item 19 might include, at a high level, potential sales, income, gross or net profits, or “break-even” figures. It may comprise of both historical results and/or future projections. It may show results of not only other franchised units, but of company owned units as well. Although gross revenue is a common subject in an item 19, sometimes you will find figures on number of customer visits, transaction counts, average transactions, and even expenses. Because of this wide range of formats and content, it’s important that you not only read what IS there, but also identify what ISN’T there ie. high revenues don’t necessarily mean high profits.
The information you do not get from an item 19 is best addressed with an actual current franchisee. An addendum or exhibit to the FDD will contain a list of franchisees, their address and contact information.
What if there is no financial information provided in an Item 19 ?
If there is no financial information provided in an Item 19, don’t stop your research on this franchise or disregard it as an option. It could be a gold-mine business that either has chosen not to include this data in their item 19 or are simply too young to have substantial data to report. If this is the case, FDD Item 20 (List of Franchised Outlets) and Item 21 (Financial Statements), are also significant indicators of a successful or not-so-successful franchise. Also, direct dialogue with current franchisees will always be beneficial and is highly recommended.