Beware of those ‘sample’ franchise figures

The aggressive use of sample financial statements is a common cause of disputes…Pro formas are obviously designed to show a positive business opportunity; in this case, the franchisor takes no responsibility for the numbers being achievable.

The Globe and Mail
June 5, 1995

Beware of those ‘sample’ franchise figures
John Southerst

JohnSoutherst.jpg

The question every prospective franchisee wants answered is: “How much will I make?” Eager to help, the franchise marketer trots out financial statements from a typical healthy franchise. The problem is: It’s not the same franchise. Every neighbourhood is different in traffic patterns and buying power – and a new store will take a few years to find its feet.

It’s a situation ripe for franchisees to claim misrepresentation. The aggressive use of sample financial statements is a common cause of disputes. “I’ve seen situations where franchisors use numbers just to make sure the franchisee sees a bottom line,” says Ken Purvis of Retailink, a Calgary franchise consultancy.

Franchisors supposedly use these statements, called “pro formas,” to show financial results that are achievable by following their systems. But the danger of misleading investors is causing many franchise consultants to urge franchisors to use pro formas with extreme caution – or not at all.

Mr. Purvis, for instance, advises franchise sellers to work with actual statements, preferably from franchises similar to the one under consideration. Every relevant detail should be disclosed: area population, demographics, age of store and so on. Alternatively, he would take average figures from statements for about 10 outlets – and the franchisor would still divulge circumstances of each store. Prospective franchisees are left to compare their situations.

The use of pro formas creates dilemmas for both sides. Potential investors need to see numbers to justify putting up money. So franchisors often issue pro formas with a disclaimer that says, in effect, the numbers are only “examples” and franchisees shouldn’t necessarily expect these results.

But this hardly seems fair. Pro formas are obviously designed to show a positive business opportunity; in this case, the franchisor takes no responsibility for the numbers being achievable.

Alberta seems to agree something’s wrong with this. The province is the only one to restrict pro formas, demanding they normally be based on actual results and not forecasts, using reporting standards set by the Canadian Institute of Chartered Accountants. (Other provinces depend on the common law governing misrepresentation.)

Would-be franchisees must realize they’re on their own in an unequal relationship. Mr. Purvis recommends they call every franchisee in the chain – or at least half of them – and not just the ones offered by the franchisor. Ask the key questions: What were you told? What was your actual performance and what is it now? How long did it take to get to where you are now?

“I’ve send a lot of enthusiastic would-be franchisees who decided not to proceed after doing the due diligence,” says Mr. Purvis, a former franchise lawyer who also owned several fast-food franchises.

Some franchisors are taking measures to see that would-be franchisees keep their eyes open. Active Tire & Auto Centre Inc., the Toronto-based service centers and Green + Ross tire stores, shows potential investors a statement based on averages across the 33-store chain. It’s a way of showing what’s possible based on experience, says executive vice-president Michael Claener.

But Mr. Claener also makes them research their own areas and come back with what they think they can do and why. “It’s what they should be doing anyway, and it drives home the point that our numbers are only a basis for their own business plan.”

Financial openness is a touchy issue. Franchisees are frequently personal investors putting up a good part of their life savings. They are required to reveal every detail of their own assets, debts and financial histories.

Meanwhile, the franchisor is often a private company that refuses to open its books. For an industry built on trust, all the trust appears to be on one side and all the power on the other.

Doing the right homework can help correct some of that inequity. “Franchisees should remember,” Mr. Purvis says, “that when they phone a franchisor to check out a franchise, they’re connected to a salesman. It’s one-sided from the start.”


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