COVID 19 and its Effects on FPRs in Disclosure Documents

One of the more confusing sections of an FDD (Financial Disclosure Document) is Item 19. Item 19 is the section where a franchisor provides financial performance information to help future franchisees decide whether to invest in a franchise system. This is the section prospective franchisees look to when asking the impossible question – how much will I make? This question is difficult if not impossible to answer, but Item 19 is the section of the FDD that comes the closest. There are many rules and regulations governing how information in Item 19 should be presented, but most franchise systems offer past sales data in some form.

The pandemic affected each franchisor in different ways. Some saw profits dive, and others saw profits soar. For some, these changes were temporary, for others permanent. If a financial performance representation in Item 19 is based on sales prior to or during the pandemic, it may be showing data that is not current with existing operations. The North American Securities Administrators Association’s Business Opportunity Project Group (“NASAA”) recently came out with an opinion on the challenges for Item 19 in the unprecedented situation we find ourselves in.

While many of these franchise performance representations may be purely factual and comply with federal and state requirements, the purpose of an FDD is to provide information to prospective franchisees to help them make a decision regarding a franchise. If the information provided is misleading, it is not only unhelpful for the purpose for which it was intended, it directly conflicts with such purpose. According to the NASAA’s opinion, even historically accurate data may contain an omission of material fact, which is not allowed under franchise statutes. A franchisor should no longer use Item 19 data that is not updated to reflect the changes brought by the pandemic unless a financial performance representation clearly states that the information comes from pre-pandemic sales.

Advice For Franchisees:

While one should not ignore Item 19 disclosures altogether, there are additional considerations. Contacting current and former franchisees is vital:

• Find out if their business has changed because of the pandemic, and if so, how it has changed.
• Ask where they see their business headed.
• If business increased because of the pandemic, what do they see happening when everything goes back to normal?
• Are they bracing for lower profits?

It also may be important to reflect on whether opening a particular business in these times is wise. For many, the answer is yes. The pandemic has made many reevaluate their lives, quit their jobs, and look for another source of income. For others, the decision may be rash and based on a need for change, without thoroughly considering the pros and cons. Item 19 is only a small part of the decision.