Buying a franchise is about choosing a business that you can make money at. It’s that simple. Passion for the brand is great, but passion doesn’t put money in your pocket.
Knowing how much money you can make as a franchisee can’t be overstated. A franchisor that provides accurate and detailed sales and expense data makes it easier to construct a more accurate pro forma income statement and cash flow projection.
Franchise systems that failed to provide an Item 19 had negative growth over a 6-year period. On average, the franchise systems that provided expense data had the highest growth rates.
When crunching numbers in our database, we found a relationship between a strong Item 19 Financial Performance Representation (FPR) and successful franchise system growth. This is based on the results of our analysis on the growth of 1905 franchise systems over a 6-year period determined by three categories of Item 19 disclosure; No Item 19, an Item 19 without expense data and an Item 19 with expense data. These are based on 2016 FDD disclosure.
No Item 19 Disclosure
In this comparison, there were 870 franchise systems, or 45% of our sample franchise group, that didn’t provide an Item 19 FPR. All professionals within franchising might intuitively say that franchise systems without an Item 19 may not be growing. Our data supports that intuition. Franchises without an Item 19 shrunk by 306 locations or -0.2% between 2010 and 2016. Outlet numbers decreased from 135,154 franchise locations to 134,348 locations.
We all assume that franchise systems without an Item 19 do so because they lack the positive franchisee results, having s financial performance. The data shows that those franchise systems without an Item 19 haven’t grown. But ironically, until we see the franchisee results of these systems, the reasons why are assumed but not verified.
Item 19 Without Expense Data
As a complete reversal to those franchise systems without an Item 19, franchise systems that provide an FPR have grown by 13.1% since 2010. Our database sample consisted of 652 franchise systems that grew from 136,885 locations to 154,812. It is quite a contrast between the +17,927 and -306 locations.
Disclosure in this group took on many variable forms but some general presentations include; system wide gross sales and quartile breakdown (in average and median). Most disclosures identified that they only included franchisee locations open more than one (or two) years.
I have some reservations about the type of disclosure and a system wide average is by no means a true testament of the success of a franchise system. But the facts show a stark contrast.
Item 19 With Expense Data
Expense data gives you a way to estimate how much money is left at the end of the day. Franchisors who provide expense data in their Item 19 grew by the largest margin at 18.4%. The 383 franchise systems grew from 131,111 to 155,195 since 2010. Or a total net growth of 24,084 locations.
Franchisors disclose expense data in a number of ways including through Gross Margin (dollars or percentages), EBIT (Earnings Before Interest and Tax) or EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). Some will provide percentages of certain types of expenses, such as advertising or payroll. Others will detail expenses per location, or based on quartile averages. The presentation varies, but there is some form of expense or profit identification.
Conclusions
What does this mean when you’re going to buy a franchise?
Franchise systems that failed to provide an Item 19 had negative growth over a 6-year period. On average, franchise systems that provided expense data had the highest growth.
This should not be the only reason why you would choose a specific franchise. The numbers above are very telling. But there are franchises without an Item 19 that have grown. And there are franchises with expense data that have shrunk.
It’s safe to say that on average, those with expense data can be better investment opportunities. But you need to do a lot more work than that to find a healthy investment.
Download our Facts & Figures to read more.
Source: Buying a Franchise