Item 19 is the first page most buyers flip to, and the one they read least carefully. Knowing how to read Item 19 can save you from buying a business based on numbers that were never going to be yours.
Nothing in Item 19 has to be dishonest to mislead you. A true number, presented a certain way, can still give you the wrong idea.
What Item 19 Is
Item 19 is the “Financial Performance Representations” section of the Franchise Disclosure Document. Under the FTC Franchise Rule, a franchisor doesn’t have to give earnings information. If it does, it needs a reasonable basis and written substantiation, and the claim has to appear in Item 19.
If a franchisor makes no claim, Item 19 has to say so. It also has to say it doesn’t authorize its people to make earnings claims orally or in writing. So if a salesperson gives you numbers that aren’t in Item 19, that’s a problem. For a tour of the whole FDD, see What Is an FDD, and What Should I Look For in It?
How to Read Item 19: Start With Who’s Included
The rule requires the franchisor to say whether the numbers cover all outlets or only a subset. It also has to give the total number of outlets in the period, how many had the described characteristics, and how many were actually used.
Find those numbers first. If the system has many units and the chart covers a small group, ask why. Maybe it’s only units open more than two years. Maybe it’s only company-owned stores. Either one can look very different from a brand new franchise.
Find How Many Hit the Number
This is my favorite line in any Item 19. The rule requires the franchisor to disclose the number and percent of included outlets that actually reached or beat the stated results.
If the average is strong but only a minority of units reached it, a few big performers are carrying the average. The FTC’s buyer guide warns about exactly this.
Watch Out for Sales Dressed Up as Profit
A lot of Item 19s show gross sales. That’s useful, but it isn’t profit. Rent, labor, cost of goods, royalties and loan payments all come out before you get paid. I walk through that math in How Do I Know If a Franchise Is Actually Profitable?
Check the Dates and the Differences
The rule requires the dates when the results were achieved. A great year may not repeat. The franchisor also has to point out characteristics of the included outlets that may differ materially from yours, such as location type, competition, or how long they’ve been open. Read those footnotes slowly.
Forecasts Need Their Assumptions
If Item 19 includes a forecast instead of past results, the franchisor has to state the bases and assumptions behind it. Test every assumption against your market, your rent and your wages.
Ask for the Backup
Item 19 must tell you that written substantiation is available on reasonable request. Ask for it. Then have an accountant look at it with you. Item 19 also has to warn that your results may differ. Take that warning seriously.
Want Help Reading an Item 19?
If you have an FDD and want a second set of eyes on the earnings section, I’m glad to go through it with you. Straight talk, no pitch. Call me, John Henning, at 267-417-4980.
Sources
- 16 CFR 436.5(s), Item 19 Financial Performance Representations (eCFR): https://www.ecfr.gov/current/title-16/chapter-I/subchapter-D/part-436/subpart-C/section-436.5
- FTC, A Consumer’s Guide to Buying a Franchise (Sept. 2020): https://www.ftc.gov/business-guidance/resources/consumers-guide-buying-franchise