Navigating Item 19: Strategies for Boosting Your Franchise Sales -

There’s an old adage that the worst presentation is the one that’s never given. This seems to be a mantra many franchisors apply to the presenting financial data in their Item 19 disclosure in their Franchise Disclosure Document (FDD). Too often, franchisors rush to publish an Item 19, despite results that might not be as stellar as hoped.

Item 19 of the FDD is like a peek behind the curtain. It’s where franchisors can showcase the potential earnings of their franchise units. It’s akin to the section of a dating profile where people list their most impressive achievements. While it doesn’t tell the whole story, it certainly captures your attention.

The primary reason franchisors opt to present an Item 19 is their belief it is the key to unlocking significant future sales. While this might seem like the ‘easiest path,’ it’s not always the wisest choice.

Consider the fitness industry, for example, where I recently conducted a study. One of the sector’s most successful concepts, Orange Theory, chooses not to disclose an Item 19. They operate over 1100 units and have ranked as high as 23rd on Entrepreneur Magazine’s Franchise 500 List. If an Item 19 is so crucial to a franchise system’s sales, how has Orange Theory achieved such remarkable success?

Interestingly, depending on the franchise industry, 20-50% of concepts opt not to present this data. So, how do they manage to sell units?

In my view, many franchisors rely on presenting Item 19 data as a crutch. Although this information can certainly aid in growing a franchise system, there are several other tactics in the sales process that can be equally, if not more, effective.

As an outsourced CFO, you might be thinking this article is counter-intuitive to most advice someone like me would give. This is not to say that financial performance is not important. Financial performance is a critical element that will determine if a prospect moves forward. But, there is a better way to go about this.

In this article, we’ll explore how to execute a sales process without Item 19. We’ll share three critical factors to present to your prospects to help them evaluate whether your system is the right fit for them.

Strategy 1: Teach The Flaws with Item 19 Data

I have put together several Item 19 presentations for clients. While I use a high ethical standard for this presentation, I can’t help but question why the industry has chosen to present data in this manner. There are several flaws in the data presented in Item 19s.

Firstly, the data is unaudited. This means that the financial information provided by franchisees, who are often not bookkeepers, is only as reliable as their reporting skills. Franchisors’ obligations in gathering this data do not extend to verifying its accuracy through independent audits. They rely on the information franchisees provide, which can vary greatly in quality.

Secondly, the net income reported for small businesses can be highly inaccurate due to the commingling of personal and business expenses. It’s not uncommon for a franchise owner to use a single account for both business expenditures and personal expenses. For example, a franchisee might charge a all of their fuel to a business credit card (hopefully the IRS isn’t reading this), thereby inflating business expenses and understating net income.

Franchisees exhibit varied levels of operational efficiency. Skills and experience differ significantly across the board, leading to wide variances in profitability, even within the same franchise model. Franchisors don’t exclusively showcase their top-performing franchisees in Item 19. Therefore, the data often reflects a broad spectrum of operational skills and other variables, including geographical differences.

Presenting this reality clearly to prospects is in franchisors’ best interest. While many potential franchisees clamor for this data, it should be approached with caution. At its best, the data requires careful interpretation; at its worst, it could lead to poor financial decisions. By understanding the nuances behind Item 19 data, prospects can make more informed decisions, ones not solely based on the results of other franchisees.

Strategy 2: Focus on Differentiators and Efficiencies

As I highlighted earlier, I have been taking a deep dive into the franchise fitness industry. After of food concepts, health and wellness may be the second largest segment of franchising. It constantly amazes me how many fitness concepts there are. At least on the surface, several of them are the same.

If this is true, then how does one separate themselves to a prospective franchisee?

First, lets take a step back. In my personal opinion as an outsourced CFO, several of these franchise businesses are bad concepts. They should have never been franchised in first place. Yes, the owner most likely had some great success with their location. However, that doesn’t necessarily mean the concept will work without them running it.

This is an important theme to note. The owner in several of these business is the differentiator or the reason for efficiency. Sadly for any franchises that open up the concept, the original owner is one trait that can not be duplicated.

Franchise concepts with lasting success have key differences and efficiencies. For anyone thinking about franchising their business, they should watch “The Founder”, the story of Roy Kroc. Set in the 1950s, it shows how the efficiencies in his business were innovative and created a real competitive advantage for a McDonalds franchisee. There is a scene in a parking lot where he has a chalk outline of the kitchen of one of his locations and how each employee will operate. For restaurants during this time, this was true innovation.

True differentiators or efficiencies will sell your concept to prospective buyers. Further, if you can numerically detail out the advantages these will give the buyer, this will be heavily impactful on their decision.

Here is the truth – several concepts can’t do this because they don’t exist. If your reading this article and I am describing your business, then this may be you. However, if you can truly detail to a buyer why your business is unique, will make them more money, and save them time, then this will be something that is truly unique.

Strategy 2 in Action: Orange Theory

Take Orange Theory, for example. What sets it apart, or what efficiencies does it offer? At its core, Orange Theory’s differentiator lies in its unique blend of technology, workout methodology, and community engagement. The brand leverages heart rate monitored training to encourage an efficient, scientifically-backed workout that promises maximum results. This technology allows members to track their progress in real-time, pushing them towards their fitness goals through a mix of endurance, strength, and power workouts.

Orange Theory’s success is more than technology. It’s about building a community. Members praise the motivational atmosphere. They also value the attention from skilled trainers. These factors drive loyalty and satisfaction. This feeling of belonging and achievement transcends a mere workout. It becomes an experience.

Franchisors should take note of this success. The lesson is to highlight your unique selling points. It could be a novel product. Or a unique service model. Maybe it’s unmatched customer experience. These elements attract and keep franchisees and customers. Struggling to find your standout feature? It might be time to rethink. In franchising, being different isn’t enough. You need to be markedly better.

Strategy 3: Teach Buyers How to Forecast Their Results

It’s widely recognized in surveys and studies on financial literacy and business management that a significant portion of the population feels intimidated by financial tasks, including forecasting. This is why so many perspective buyers also rely on data presented in the Item 19 as a crutch.

Financial forecasting involves predicting future revenues, expenses, and other financial details of a business. It requires a good understanding of finance, accounting, and business principles. Many people, especially those without formal education in business or finance, might find these tasks daunting due to the complex analysis and mathematical skills required.

This also presents a problem for franchisors. Near 100% of the problems franchisors have with their franchises are a result of financial issues. If the problem presents itself in a different way, the underlying issue often goes back to finances. A large portion of these issues could be headed off if a proper forecast was developed at the front end of the sales cycle. A forecast sets expectations. Often a buyer of a new franchise does not have expectations set or has them set in a unrealistic way.

Franchisors can significantly aid prospective franchisees in their financial planning by providing a blank financial model. These models act as a foundational guide, highlighting potential expenses, revenues, and cash flows. They allow franchisees to create personalized financial forecasts, making the daunting task of financial planning more approachable. As an outsourced CFO, I have built these for clients in a way that complies with FTC rules, yet also gives the prospect a roadmap on how to build their own forecast.

Industry benchmark reports are another critical tool that franchisors can offer. These reports shed light on average costs, revenues, and profit margins within the industry. They help prospects understand where their potential business might stand in comparison to industry standards, providing a clearer picture of what to expect.

Consultation services further enhance the support system for franchisees. By offering access to financial advisors or consultants familiar with the franchise’s specifics, franchisors ensure that franchisees receive expert advice. This personalized guidance is invaluable for navigating financial planning and forecasting effectively.

Lastly, it’s essential to understand the FTC’s rules regarding what franchisors can and cannot do with financial representations. Franchisors are allowed to provide financial performance representations in Item 19 of their FDD, but these must be based on actual historical data. They cannot make speculative financial performance predictions or provide unsubstantiated earnings claims. By adhering to these guidelines, franchisors can support their franchisees’ financial planning efforts without overstepping regulatory boundaries, ensuring a transparent and trustworthy relationship.

Hardwork = Success

In navigating the complex landscape of franchise sales, understanding the strategic use of Item 19 is crucial. Through examining its limitations, emphasizing differentiators and efficiencies, and guiding franchisees in financial forecasting, franchisors can create a more robust and appealing proposition. It’s about moving beyond the numbers to showcase the unique value and potential success that lies within a franchise system.

Orange Theory serves as a prime example of how focusing on what sets a franchise apart. Empowering prospective franchisees with the tools and knowledge to perform their own financial forecasts not only aligns with FTC regulations but also sets the stage for more informed and realistic expectations.

Ultimately, the essence of franchising success lies not just in the financial performance data but in the strength of the brand, the community it builds, and the support it offers to its franchisees. As franchisors strive to present their franchise opportunities in the best light, adhering to FTC guidelines while providing comprehensive support and transparency will pave the way for mutually beneficial outcomes.

Krieger Analytics Can Help

Krieger Analytics has several small business owners who rely on them as their outsourced CFO. These businesses range in size ($1M to $15M in sales) and industries. We are an expert in servicing small businesses because we have been entrepreneurs. Our expertise doesn’t just come from theory, it comes from practice.

Contact us now if you want to learn what a CFO can do for your small business. We’d love to see if we are a good fit and can help you accomplish your goals.