Registration and Disclosure

“How much can I make?” That is typically the first question a prospective franchisee asks when evaluating a franchise opportunity. If you are considering franchising your business, ask yourself whether you have financial information you can, and want, to provide to prospective franchisees that will answer this question.

By law, a franchisor can only give financial information to prospective franchisees in its franchise disclosure document. The information you provide can be actual, historic results, or it can be projections. However, in either case, the information must be based on actual results from your system. Thus, it is not permissible to simply give a hypothetical, such as “if you sell only $400,000 a year, here is what you will make,” unless you actually had an outlet that had $400,000 of revenues. You can use the results of company-owned outlets, so long as you show the differences, like royalty payments, that would have occurred had the outlets been operated by a franchisee.

From a practical standpoint, you can present financial information to prospective franchisees even if you have only one operating outlet. However, if that one outlet turns out to be an aberration, you are likely to have unhappy franchisees when they cannot replicate the success of that outlet. Thus, it has always been our advice that a company has financial information from at least two outlets before including financial results in their disclosure document.

If you want to franchise your business and do not have any company-owned operations, you can still offer franchises, but you will not be able to answer a prospect’s questions about what they can make. That will put you at a competitive disadvantage with other franchisors who provide this information to prospective franchisees. Indeed, the majority of franchisors now include financial information about their individual outlets in their disclosure documents.

There is one last question to ask yourself, perhaps before embarking on a developing a franchise program. Assuming you have results to show prospects, ask yourself whether the results of your existing operations would entice prospects to acquire a franchise from you. If your past results are weak, you may want to focus on strengthening your brand before embarking on franchising. After all, franchisees are buying into your success, and you want your franchise program, and your initial franchisees, to get started on the right – i.e. profitable – foot.

New franchisors are surprised to learn that they are prohibited from providing financial information to prospective franchisees unless the information is contained in the form of a financial performance representation (“FPR”) in Item 19 of the franchisor’s Franchise Disclosure Document. The inability to provide this information leaves new franchisors with the difficult task of selling the franchise opportunity without being able to answer the question of “how much money can I make from the opportunity”.

However, with the issuance by the North American Securities Administrators Association, Inc. (“NASAA”) of the final NASAA FPR Commentary (the “Commentary”) on May 8, 2017, the process should have become arguably easier, or at the very least filled with less uncertainty.

The Solution

The Commentary provides clarity on what constitutes a reasonable basis for making an FPR. The Commentary clarifies that company-owned results can be used in making an FPR but details the information that must accompany the disclosure of those results. A franchisor can continue to use subsets of outlets that share a particular set of characteristics, but the subset selected cannot be misleading. For example, if a subset is based only on the highest grossing 10% of outlets, the lowest grossing 10% of outlets must also be included. Data from outlets that closed during the time period shown in the FPR may be excluded provided certain new disclosures are included concerning the number of outlets that closed during the period(s). Whenever “average” data is included in an FPR, “median” data must also be included, and vice versa. These guidelines, and others in the Commentary, should assist franchisors in making more accurate FPRs.

For more information on how you “show your prospects the money,” contact one of the authors identified above.

The Rhode Island Department of Business Regulation Securities Division (the “Department”) has amended its Rhode Island Franchise Investment Act, 19 R.I. Gen. Laws § 19-28.1-1 et seq., to eliminate its requirement that franchise advertising materials created or used by the franchisor be filed with the state and to change the waiting period for delivering a franchise disclosure document (“FDD”) to a prospective franchisee to 14 calendar days.  The Department issued Franchise Bulletin Number 2016-1 [PDF] summarizing these changes.

Franchisors should be aware of these changes if they offer or sell franchises in Rhode Island, as the changes will not only affect the offering and selling of franchises (by no longer requiring advertising be filed with the state and changing the delivery period), but the receipt pages of your FDD may need to be updated to account for the 14 calendar day delivery period.

Advertising Filing

Effective June 27, 2016, Rhode Island has eliminated the franchise advertising filing requirement by amending 19 R.I. Gen. Laws § 19-28.1-12.  Previously, franchisors offering or selling franchises in Rhode Island had to typically file their advertising materials with the state and pay a filing fee at least 5 business days prior to using or publishing the advertisement.  Rhode Island has eliminated this filing requirement and its associated fee. 19 R.I. Gen. Laws § 19-28.1-12 now reads:

§ 19-28.1-12 Advertising.

No person may publish in this state any advertisement offering to sell a franchise required to be registered under this act unless they maintain the advertising materials for five (5) years, consistent with § 19-28.1-13.

Franchisors must still keep required records of their Rhode Island advertising materials for 5 years, consistent with 19 R.I. Gen. Laws § 19-28.1-13.

Delivery of FDD

Also effective June 27, 2016, franchisors are required to provide the FDD to prospective franchisees at least 14 calendar days prior to the signing of any binding agreement by a prospective franchisee or at least 14 calendar days prior to the direct or indirect receipt of a franchise fee, whichever comes first.  The 14 calendar day requirement is consistent with federal law under the Amended FTC Rule.  Previously, Rhode Island required franchisors to provide the FDD to prospective franchisees at least 10 business days before signing the franchise agreement or accepting a franchise fee, or if earlier, at the time of the franchisor’s first personal business meeting with the prospective franchisee. 19 R.I. Gen. Laws § 19-28.1-8 now reads:

§ 19-28.1-8 Delivery requirements.

(a) It is unlawful to sell any franchise in this state without first providing a copy of a disclosure document reflecting all material changes together with a copy of all proposed agreements relating to the sale of the franchise, unless otherwise provided in subsection (b), to the prospective franchisee, not less than:

(1) [Deleted by P.L. 2016, ch. 153, § 2 and P.L. 2016, ch. 159, § 2].

(2) Fourteen (14) calendar days prior to the execution of an agreement or payment of any consideration relating to the franchise relationship.

(b) The delivery requirements in subsection (a) do not apply to the offer or sale of a franchise which is exempt under § 19-28.1-6(2), (3), (6), or (8).

The change to Rhode Island’s delivery requirement will make it easier for franchisors offering or selling franchises in the state, as they do not have to juggle between the 10 business day/first personal meeting rule on the one hand and the 14 calendar day requirement under federal law on the other.  However, franchisors should review the receipt pages attached to their FDD to revise any references to Rhode Island’s previous delivery requirement prior to making their annual renewals this year.

For more information on these changes, see Franchise Bulletin Number 2016-1 [PDF] issued by the Department or contact your franchise attorney.

2017 Checklist for Franchisors: Updating Your FDD, originally published on the International Franchise Association’s Insider Blog, provides a checklist of items franchisors should consider as they start updating their franchise disclosure document (“FDD”), including regarding:

  • Franchise registration deadlines
  • Accountants
  • Operations
  • Sales team
  • Manuals
  • Item 20 (outlet information) in the FDD
  • Item 19 (financial performance representations) in the FDD
  • Franchise advertising
  • Insurance coverage