Earnings Claims - Have We Come Full Circle?
By Carl Jeffers, Intel Marketing Systems

One of the most important issues today in the franchise industry is that of "Earnings Claims."

The question today has shifted the emphasis from "restricting franchise companies from providing earnings claims to almost "requiring or at least encouraging " them to do so.

The franchise industry is regulated by rules of disclosure and compliance requirements that were first enacted on the national level back in 1979.

Essentially, much of the motivation for those first stages of disclosure requirements was a desire on the part of Congress to curb abuses that were then considered to be running rampant throughout the franchise industry.

And at that time, the most consistent area of abuse was that of franchise companies giving excessive end overly optimistic claims of potential earnings and profits that could be realized by potential franchisees if they bought that particular franchise opportunity.

Who can forget the Sixty Minutes episodes featuring companies such as Wild Bill's Hamburgers and others that promised outlandish investment returns and profits to would be franchise operators when in fact, there was virtually little if any chance at all that franchisee investors would ultimately be able to achieve the projected levels of revenue and profit they were promised by over zealous salesmen and corporate personnel.

One of the major components of the Franchise Disclosure Rule that went in to effect almost twenty years ago was a section which limited the ability of franchisors to provide earnings claims and revenue projections to potential franchisees by first, requiring the companies to formally disclose any such claims in the newly required Offering Circular that would be distributed to all prospective franchise buyers PRIOR to them consummating any franchise purchase, and second, requiring that if the franchisor did disclose revenue and earnings claims and projections in the Offering Circular, those claims and projections had to be substantiated by the existing and demonstrated track record of stores and outlets currently in operation, with some geographic or other similarity to the circumstances that would apply to the store or outlet to be developed by the prospective franchisee purchaser.

Furthermore, the "substantiation" material and documents had to also be disclosed and provided to the prospective franchisee purchaser in the Offering Circular, and this material had to be made available to the prospective franchisee prior to a formal franchise purchase transaction being consummated.

In the years since, many franchisor companies have actually attempted to "hide" behind the Rule and claim that they were actually prohibited from providing any earnings claims or projected revenues to potential franchisees as part of the compliance requirements of the Franchise Disclosure Laws.

But this statement was really misleading at best and false at worse. The FTC (Federal Trade Commission - the federal agency that oversees the franchise industry) never prohibited franchise companies from providing earnings claims to prospective franchisees. The agency only set certain guidelines and standards as noted above for any use of earnings claims or revenue projections as part of the franchise sales process.

Any company that elected not to provide earnings claims or projections to prospective franchisees was in fact making their own decision not to do so and not acting in accordance with any FTC restrictions or superseding regulations.

And so today, we have a situation where one of the most consistent complaints from prospective franchisees is that the franchise companies they have talked to "would not give them any kind of earnings and revenue projections" and the companies told the franchisee prospects that the "FTC prohibited them by law from doing so.'

And often times, the franchisee was left to try to get information in a restricted and unproductive approach with many companies reverting back to providing information of this type without the disclosure and substantiation requirements being met.

One thing is clear, even when the companies said they could not provide this type of information to a prospective franchisee because of the franchise laws (an untrue statement), the franchisee prospects very often still wound up getting that information from someone involved or affiliated with the company.

And frankly, the franchisee prospects need to be able to get that information.

Who really thinks that people are better off and better protected if they have to buy a brand new business opportunity costing sometimes $200,000 or more without having any idea of what kind of revenue they can expect and without being given any basis for estimating the profit they might make or the return on investment they might realize.

More important - Who really thinks anybody actually does buy a business without any of that type of information and calculations to base their decision on?

Today, the FTC has decided to act and at least attempt to reach a more practical approach in addressing earnings claims problems, or the potential for earnings claims problems.

According to language published by the FTC, the agency's goal in revamping earnings claims disclosure requirements would be to accomplish the following:

1. To make it clear that franchisors can disseminate earnings information

    

2. To inform prospective franchisees that they should not accept earnings claim information at face value without written substantiation

    

3. To warn prospective franchisees not to rely on unauthorized earnings representations

In addition, the agency would also require franchisors to disclose in a "preamble" statement that they are able to provide earnings claim information to prospective franchisees, and that this franchisor has elected not to do so.

The agency proposes to also provide a standardized basis for the criteria or "actual performance results" that the franchisor must use as the basis for any earnings claims they elect to provide to prospective franchisees.

The franchise attorneys I work with and whose opinions I respect so highly, Joe Sheyka of Rudnick & Wolfe in Chicago and Harold Kestenbaum of Garden City, New York, all feel strongly that these types of changes will significantly improve the entire franchise sales and marketing process as it now exists for franchisors throughout America.

My personal "franchise niche" and that of my firm, Intel Marketing Associates, is most often with newer, emerging franchisors who often have less than fifty franchises in place, or who sometimes have NO franchises in place as they are just initiating their franchise expansion program.

For these types of companies, I personally recommend that if they are going to provide earnings claims information to prospective franchisees by providing it in the circular, they should create a model of three (3) estimates of potential revenue and earnings ranging from "Low, Average, and High."

These three categories should make every effort to allow for various costs that will vary from location to location such as rents (malls vs. street fronts and major urban cities vs rural suburban areas), labor costs (high geographic labor costs vs lower areas), food costs, and location demographics. Furthermore, the categories should clearly define the basis on which the estimates (particularly revenue and profit estimates) were based.

All three estimates (low, average, and high) should then be disclosed in the circular along with the notations of the various factors that will affect which category the franchisee might wind up in - as noted above, and then, in bold type, the following statements should be added:

1. These numbers are estimates only and not actuals

    

2. These numbers are based solely on our 1 or 2, etc. outlets in operation now (franchises) with the oldest unit open for 1 year Or

   These numbers are based solely on actuals from our company Outlets as we have no franchise outlets in operation as yet

3. Our company outlet or outlets have only been open since.....

    

4. Differences in geographic variables must be taken into account when considering opening an outlet in your area

    

5. Factors affected by varying degrees of management ability will also affect the results of any particular location

"However, based on the experience we have had in this business since our opening in (July of 1996 as an example) we do believe this information can be a useful tool for a prospective franchisee to consider as he evaluates all aspects of our program including corporate management, training, and other areas addressed in the Offering Circular."

Something along the lines I have proposed above, with all of this and the actual estimates disclosed in the Circular will help those new, emerging franchisors to address this issue.

And it probably will be necessary. With no franchises open or only one, two, or three in operation, new prospective franchisees will even more vigorously pursue getting information to enable them to project what kind of revenue they might be able to generate in the business or what level of profits and return on investment might be reasonable to expect.

This approach will at least provide a working model of what might work.

But if, as a new and emerging franchisor, the company elects NOT to provide any type of earnings claim information, that company will no longer be able to "hide" behind a deliberate misinterpretation of the disclosure rule and say that they are "prohibited" from doing so.

And that company must make sure that it does not permit information of this type to be disseminated to prospective franchisees "outside" of the realm of the Offering Circular and the information the company provides in that document.

Don't let your franchise sales representatives make mistakes in this area. They can and will be very costly for the company.

Our firm, Intel Marketing, can come in and do a half day seminar to coach your franchise sales staff on proper and effective methods of handling this and other areas of the franchise sales and marketing process, and of course, Intel can also be retained to actually take over the franchise sales and marketing responsibilities for your company and actually become your marketing arm with the expertise and knowledge gained from fifteen years of direct, dedicated experience in the franchise industry.

We started out twenty years ago putting restraints on earnings claims to fight abuses in this area. Today, we may have come full circle to essentially require or at least encourage that everyone provide earnings claims in a measured and standardized format to help new franchisees with this most important decision.

Earnings claims may truly boost your franchise marketing efforts.

Don't let mistakes in how you handle them lead to "claims" filed against your company that might ultimately wipe out "your" earnings!

Carl Jeffers is the President of Intel Marketing Associates, a franchise consulting Firm that specializes in franchise structuring and franchise marketing and sales. Jeffers is a renowned national expert on franchising who has participated as a key panelist and speaker in seminars and conferences on franchising throughout the country. He has contributed articles to leading publications in the industry on Franchise related subjects. Intel Marketing Associates is a Seattle, Wa based firm With affiliate offices in Los Angeles. Jeffers can be reached at 425 889-8556. E-mail - cjintel@juno.com.