IFA’s 45th Annual LEGAL - Franchise.org · IFA’s 45 th Annual 5 FTC Definition • Any...

LEGAL SYMPOSIUM IFA’s 45th Annual

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IFA’s 45th Annual

LEGAL SYMPOSIUM


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IFA BASICS PROGRAM FINANCIAL PERFORMANCE

REPRESENTATIONS

Marisa Faunce – Plave Koch PLC Jan Gilbert – Haynes & Boone LLP

Greg Vojnovic – Popeyes Louisiana Kitchen


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Materials Covered • What Is A Financial Performance Representation? • Pros and Cons of Making a FPR • Drafting a FPR • Examples • Vulnerability of Sales Process Without a FPR • Compliance • Dealing with Violations


WHAT IS A FPR?

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FTC Definition • Any representation, including any oral, written or

visual representation • To a prospective franchisee • Including a representation in the general media • That states, expressly or by implication a specific

level or range of actual or potential sales, income, gross profits or net profits

• The term includes a chart, table, or mathematical calculation that shows possible results based on a combination of variables


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If your client wants to give financial information to prospective franchisees….

• They must have a “reasonable basis” at the time they disseminate the FPR

• They must have written substantiation and make it available to prospects who ask

• They must include the FPR in Item 19 of their franchise disclosure document


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Examples • Franchise Times reported that our average units do more than

$15,000 per week in sales. • You will break even in 15 months. • You will see a 100% return on investment within the first year of

operation. • You will earn enough money to buy a new Porsche. • Most all our franchisees are clearing $1,000 a week. I don’t know

anyone who is making less than that. • We can make you a millionaire. • You can expect annual sales of $225,000 and a profit margin of 33%.


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Examples • In 2011, our company-owned units experienced average

gross sales of $750,000. • In 2011, the gross revenues of our franchised units ranged

from $550,000 to $850,000.

# of Units Avg. Sales # Above Avg. # Below Avg.

49 $650,321 19 30


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Examples

• Statements of Gross Sales, Gross Margins, Gross Profit or Net Income almost anything that relates to operating results

• Average unit revenues or income • Return on Investment • Annual Break Even • Media claims – articles provided to prospects


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Measures of • Average ticket • Number of jobs per day per technician • Average revenue per day • Average revenue per unit, van, kiosk • Value of national accounts • Sales closing rates • Vacancy/Occupancy rates of hotels, classes, etc. • Yield from an amount of product sold or service

performed


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Expressions of Frequency

• Quarter-over-quarter increases in same-store sales • Percentage of rebookings • Percentage of repeat business • Average backlog • Average number of customers • Average price per service • Effect on gross sales for units adding new equipment


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What is NOT a FPR?

• Statements made to existing franchisees and lenders

• Cost or expense information that is not stated as a percentage of overall sales

• Puffery


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What is NOT a FPR ? • Prospects obtain industry information

(on their own) – Joe’s Sub Shops average $600,000 per year in net sales.

• Blank Pro Formas


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Alternate Means of Disseminating Financial Information

• Operating results of units offered for sale • Press releases, SEC filings, financial statements • Existing franchisees


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Do franchisors have to make a FPR?

• No, but . . . – They need to include a statement to that effect in

Item 19 of the FDD – They cannot later provide any financial

information to a prospective franchisee


PROS AND CONS OF FPRS


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Reasons To Make A FPR

• Primary importance to a prospective franchisee • Franchisees who do their own due diligence may

not receive reliable information • Disclaimers protect the franchisor • Supplemental representations for particular units

are permitted • Multi-Unit developers demand the information • Competition • Brokers may insist on having the information


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Reasons Not To Make A FPR

• Relevance of data to the franchise offered • Information becomes public • Difficult to collect reliable data from franchisees • Expense of acquiring data, and preparing and

maintaining the disclosures • New or small systems may not have enough data

to make the representation meaningful • Experienced franchisors with new or substantially

modified systems may face similar issues


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DRAFTING A FPR


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Required Preamble #1 • “The FTC’s Franchise Rule permits a franchisor to provide

information about the actual or potential financial performance of its franchised and/or franchisor-owned outlets, if there is a reasonable basis for the information, and if the information is included in the disclosure document. Financial performance information that differs from that included in Item 19 may be given only if: (1) a franchisor provides the actual records of an existing outlet you are considering buying; or (2) a franchisor supplements the information provided in this Item 19, for example, by providing information about possible performance at a particular location or under particular circumstances.”


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Required Preamble #2 – if no FPR is made

• “We do not make any representations about a franchisee’s future financial performance or the past financial performance of company-owned or franchised outlets. We also do not authorize our employees or representatives to make any such representations either orally or in writing. If you are purchasing an existing outlet, however, we may provide you with the actual records of that outlet. If you receive any other financial performance information or projections of your future income, you should report it to the franchisor’s management by contacting [name, address, and telephone number], the Federal Trade Commission, and the appropriate state regulatory agencies.”


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Historic Performance

• Must state the material facts underlying the representation. Item 19 of the amended Rule specifies six separate elements comprising the material bases for such a representation, each of which must be expressly addressed:


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Historic Performance, cont’d.

1. The Group Measured - – Did All Outlets in the System, or Only Some of

Them, Achieve the Stated Level of Performance? – Are the Outlets in the Measured Group

Franchised Outlets? Company-owned? Outlets of an Affiliated System with Similar Operations?


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2. Time Period Measured – – When Was the Stated Level of Performance

Achieved?

3. Number of Outlets Measured - – How Many Outlets Are in the Group That

Achieved the Stated Level of Performance, and How Many Are in the Entire System?


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4. Number of Outlets Reporting – – How Many Outlets in the Relevant Group Supplied the

Performance Data Underlying the Representation – Issues: low percentage reported; those that reported are

not indicative of group; why did franchises not report ?

5. Number and Percentage of Outlets that Achieved the Stated Level of Performance -

– What Proportion of the Group Measured Achieved the Results Claimed ?


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6. Distinguishing Characteristics - – What Are the Common Attributes of the Outlets

That Achieved the Stated Level of Performance? • E.g., square footage, drive-through, urban vs. rural

locations, corner location, etc.


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Projected Performance

• Projections must have a reasonable basis, and must disclose the material bases and assumptions upon which the projection is based.

• Item 19 disclosures must include sufficient facts to enable a prospective franchisee to make an independent judgment as to the validity of the projection.


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Admonition

• A clear and conspicuous admonition that a new franchisee’s individual financial results may differ from the results stated in the Item 19 disclosure. No specific language is required, but the FTC provides samples.


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Samples

• For historical representations: “Some outlets have [sold] [earned] this amount. There is no

assurance you’ll do as well. If you rely upon our figures, you must accept the risk of not doing as well.”

• For projections: “These figures are only estimates of what we think you may

earn. There is no assurance you’ll do as well. If you rely upon our figures, you must accept the risk of not doing as well.”


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Availability of Substantiation

• May show a prospective franchisee the actual operating results of a specific outlet being offered for sale

• Applies only to potential purchasers of that outlet and no others


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Supplemental Representations

• If a franchisor has furnished an Item 19 disclosure, it may furnish a supplemental financial performance representation pertaining to a particular location or pertaining to a particular variation (e.g., a kiosk, as opposed to a standard free-standing restaurant).

• Must be in writing, explain the departure from the financial performance representation set forth in the Item 19 disclosures, and be prepared according to the Item 19 standards for financial performance claims.


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Practical Tips • Determine what information you wish to present (much

latitude: e.g., sales, expenses, profit, occupancy rates, number of customers/transactions, number of products sold). Speak to business people.

• Determine whether franchisor has reasonable basis; assess quality of information

• Determine format (e.g., comparative info, graph, subgroups, tiers.)

• Confirm FPR is not misleading, inaccurate, or incomplete


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Excluding Data - Limiting Claim • Offering full range of services • Working business full time • Submit all required reports • Representative of future units • Common size • Reporting on a particular POS, or using a particular

accounting program • Sent P&Ls, tax returns or other reports


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Substantiating Data

• Document material assumptions • Maintain summary spreadsheet and back-up records of

all “adjustments” made to the actual raw data, and keep as “substantiating documentation” in files to produce upon request.

• Know why you excluded any store which otherwise meets selection criteria.


EXAMPLES

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Sales Bands Franchised Restaurants Average Sales Above

$1,100,000

Sales Between $900,000 and

$1,100,000

Sales Below $900,000

Sales Range Average $ $ $ $ No. of Restaurants in Range No. of Restaurants Above Average

% of Restaurants Above Average

% % % %

Food and Paper Costs Average $ $ $ $

% of Sales % % % % No. of Restaurants Above Average


% % % %

Labor Costs Average $ $ $ $ % of Sales % % % % No. of Restaurants Above Average


% % % %


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Jan 2011 - Dec 2011

AVERAGE SYSTEMWIDE GROSS SALES

$

NO OF UNITS

Averages

No. of Stores Above

Average

% of Stores Above

Average

Cost of Goods Sold $ %

Gross Profit $ %

Comps/Discounts $ %

Labor (Hourly & Mgmt) $ %

Total Operating Expenses $ %

Advertising Expenses $ %

Fixed Costs & Depreciation $ %

Occupancy $ %

Restaurant Contribution $ %

Depreciation $ %


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Estimated Gross Margin for Acme Mufflers Sold in Franchised Stores. We estimate that our franchisees will experience a gross margin of 30% to 38% depending on the volume of Acme mufflers purchased from our designated supplier, ST Industries. The calculation of the estimated gross margin is based on Acme mufflers cost projections from ST Industries for 2012 and an estimated retail sales price of $69.99 based on our current marketing strategy. There is no guarantee that a franchisee will experience a gross margin in this range. Many factors could impact the cost of the Acme mufflers purchased from ST Industries, including shipping costs, import taxes and variances in raw materials costs.


VULNERABILITY OF THE SALES PROCESS WITHOUT A FPR

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If Don’t Include... Vulnerability

• Reliance on competitors’ published earnings

information • Demands of more sophisticated multi-unit

prospects • Likelihood of unauthorized representations made

by sales staff


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Vulnerability: Broker / Outside Sellers

• Generally, first point of contact with prospect • Compliance with broker guidelines is essential • Indemnification provisions in contracts


COMPLIANCE


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Compliance

• Adopt a written compliance policy detailing the penalties for violations.

• Train salespeople and anyone else who meets with prospects pre-sale.

• Maintain disclosure records of who has received your disclosure document

• Police compliance and deal with infractions. • Compliance questionnaires


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Train everyone in the organization

• anyone who will talk to or meet a prospect – Explain the rules – Adopt a company policy that any claims or

representations related to earnings, sales or profits be in writing and limited to Item 19.


DEALING WITH VIOLATIONS


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What if there is no FPR, or the following differ from a published FPR…

• The sales person tells a prospect what they can expect to earn?

• The receptionist tells a prospect how much money Joe Franchisee made last year?

• They handed out an article that shows average system sales are $600,000 and the average check is $9?


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• Some states - private right of action for rescission and/or damages

• Public Remedies:

– Civil fine against company and/or executives personally

– Cease and Desist order against company and/or executives personally

– Criminal penalties against company and/or executives personally

• Felony if willingly ignore the rules

– Rescission and damages

Remedies


QUESTIONS

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