When you buy a franchise, you may be able to sell goods and services that have instant name recognition and you may receive training and support that can help you succeed. But purchasing a franchise is like any other investment: there’s no guarantee of success.
The Federal Trade Commission (FTC), the nation’s consumer protection agency, has prepared this information to help you decide if a franchise is right for you. It suggests ways to shop for a franchise opportunity and highlights key questions you need to ask before you invest.
You may want to know how much money you can make if you invest in a particular franchise. A franchisor isn’t required to disclose information about potential income or sales. If it does, the law requires it to have a reasonable basis for the claim when it’s made and to include the claim in Item 19 of the Franchise Disclosure Document (FDD). If a franchisor makes a claim that has a reasonable basis, the FDD also must disclose:
• the source and limitations of data that support the claim
• any important assumptions on which the claim is based
Be sure to ask the franchisor for written substantiation that supports the claim. The franchisor is required to provide substantiation if you ask. An accountant can help you determine whether the claims are reasonable, and if they apply to how you plan to operate your business. When you review earnings claims, consider:
Is the Earnings Claim Typical for a Franchise in this System?
Suppose a franchisor claims that franchisees in its system earned $50,000 last year. The claim may be deceptive if it doesn’t represent the typical earnings of franchisees. The FDD should tell you how many franchises the franchisor has, how many it surveyed to get that figure, and the number and percentage of franchisees who reported earnings at the level claimed.
Average Income
If a franchisor claims that its franchisees earn an average income of $75,000 a year, that tells you very little about how individual franchises performed. Using an average figure may make a franchise system look more successful than it really is, because the high incomes of just a few very successful franchises can inflate the average for all franchisees.
Gross Sales
Some franchisors provide figures for their franchisees’ gross sales. These figures don’t really tell about the franchisees’ actual costs or profits. An outlet with high gross sales on paper might be losing money because of high overhead, rent and other expenses.
Net Profits
Franchisors often don’t have data about their franchisees’ net profits. If you get profit information, ask if it’s based on information from company-owned outlets. Company-owned outlets often have lower costs because they can buy equipment, inventory and other items in larger quantities at lower prices or may own, rather than lease, their property.
Geographic Relevance
Earnings may vary with geography. If a franchisor provides franchisee sales or income figures, ask if any of the supporting data came from franchisees in your area. The FDD should state whether there are geographic differences between the franchisees whose earnings are reported and your likely location.
Franchisees’ Backgrounds
Keep in mind that franchisees have different skill sets and educational backgrounds. The success of some franchisees doesn’t guarantee success for all.
Reliance on Earnings Claims
Franchisors may ask you to sign a statement—sometimes presented as a written interview or questionnaire—that asks whether you received any earnings or financial performance representations during the course of buying a franchise. If they told or gave you any information about how much your franchise may earn, report it fully on the questionnaire or other statement. If you don’t, you may be waiving any right to contest the earnings representations that were made to you and that you used to make your decision to buy.
In Texas, as in other states, purchasing a franchise involves both federal and state regulations. The Federal Trade Commission (FTC) requires franchisors to provide potential franchisees with a Franchise Disclosure Document (FDD), which includes vital information about the business, including any earnings claims. Franchisors are not obligated to disclose potential income or sales, but if they do, they must have a reasonable basis for their claims and include this information in Item 19 of the FDD. The FDD should also outline the source and limitations of the data supporting the claim, as well as any assumptions made. Prospective franchisees have the right to request written substantiation of earnings claims, which the franchisor must provide. It's important to analyze these claims critically, considering whether they are typical for the franchise system, how they were calculated (average income, gross sales, net profits), their geographic relevance, and the backgrounds of the franchisees. In Texas, the Business Opportunity Act also regulates the sale of business opportunities, including franchises, and requires sellers to provide a disclosure statement to buyers. Before investing in a franchise, it is advisable to consult with an attorney and an accountant to review the FDD and earnings claims to ensure they are reasonable and applicable to your business plan.
