Alicia Miller
Responsible franchising. What does that mean to you and your franchise system?
In my experience, responsible franchising includes at a minimum: 1) Knowing your ideal franchisee and ensuring fit when recruiting. 2) Disclosing business decision makers and their experience. 3) Ensuring both franchisees and the corporate entity are adequately capitalized. 4) Ensuring salespeople/agents representing your brand are acting ethically with no misleading representations. 5) Investing in a solid training and opening program to help franchisees begin strong and ramp quickly. 6) Building solid communication and trust with your franchisees. 7) Creating and maintaining a franchise program designed for franchisee profitability.
One complaint often heard about the franchise sales process is that prospective franchisees don’t closely read the franchise agreement and the required franchise disclosure document provided to them. As of this writing, the Federal Trade Commission is still considering whether any changes need to be made to the existing Franchise Rule, including required disclosures.
During public hearings on this topic, some commenters pointed out that even if tweaks to existing disclosures are made, many prospective franchisees still won’t read the disclosures. In other words, “at around 300 pages, FDDs are long enough, so please don’t add more that no one will read anyway.”
While I’d prefer to see shorter FDDs (to encourage prospective franchisees to more thoroughly study them), I believe this brief list of changes would make franchise disclosure documents materially more useful to prospective franchisees. The changes would also support the cause of responsible franchising. Do we need this to be mandated?
Item 1: The Franchisor, Any Parents, Predecessors and Affiliates. Private equity is a significant force in franchising, but you wouldn’t know it from ownership disclosures in most FDD Item 1s. Prospective franchisees deserve to know the identity of the majority owner of the franchise brand (or platform) they are considering. The entire cap table doesn’t need to be disclosed, only majority ownership. Who is in control and the final decision-maker?
Item 2: Business Experience. If the franchise is sold through brokers channels or an outsourced sales organization, those channels should be disclosed and named.
Item 3: Litigation. Lawsuits related to outsourced sales agents should be disclosed. After all, it is likely material to the prospective franchisee that franchisees in other systems are suing a sales organization about their sales tactics. I would want to know that before talking to a sales agent. Wouldn’t you?
Item 5: Initial Fees. As a footnote to the franchise fee paid, commissions paid to sales agents (internal or external) should be disclosed. Franchisees may not realize that a significant portion of their fee is going toward sales commissions. There is nothing wrong with utilizing external sales channels to sell franchises. But any commissions paid should be disclosed to buyers relying on representations and information provided by those same salespeople and agents. You could argue that information is already contained within the financial statements. If you feel that way, it shouldn’t be an issue to also spell it out in the Item 5 so prospects can easily connect the two pieces of information, right?
Item 11: Franchisor’s Assistance, Advertising, Computer Systems and Training. If there are any potential impairments to the franchisor’s ability to offer support services outlined in the Item 11, that should be disclosed. Based on the balance sheets of many emerging brands in particular, I don’t see much available for franchisee support. Including a list of the support the franchisor “may” provide in Item 11, while not possessing the capital to actually perform those services, seems disingenuous to me. Ditto for investments in technology, training and brand advertising.
I can think of one emerging franchise that has a funnel of 320 units sold. Based on its 2022 FDD (showing 2021 numbers), 50 units opened in 2021, but that same year the franchise only spent $15,000 on franchisee training. My kid’s middle school tuition costs me more. What is the “system” that franchisees purchased? That same franchise spent $6.1 million in sales commission in 2021, mostly to an outsourced sales organization.
Item 20: Outlets and Franchisee Information. Franchisors should be required to indicate not just the units sold each year and the total funnel, but the brand’s track record getting units open over the last five years, agreements sold but terminated before the units opened, and also the percentage of units sold that were multi-packs. Multi-packs should be spelled out in detail. If 100 licenses were sold, supporting 10 franchisees opening 100 units gradually versus supporting 100 franchisees all trying to open at once, implies very different support scenarios and burdens for the organization. Also, multi-packs sold but not opened should be disclosed.
Financial statements. If “other expenses” are more than 10 to 20 percent of the corporate total expenses, the franchisor should be required to disclose details of what’s contained in the “other” category. This same emerging brand had a whopping 62 percent of its corporate expenses listed as “uncategorized” in the FDD it used to start selling franchises.
I have written about how many emerging brands work hard to sell their way into private equity’s notice by filling their license funnel as fast as possible. There are many brands already owned by private equity that also drive aggressive license sale mandates. No doubt they feel pressure to grow into the high acquisition multiples they paid. It’s two sides of the same coin.
Are prospective franchisees aware of the underlying dynamics? These simple additions to FDD disclosures shouldn’t be a documentation burden and need to be included.
This column's author bio has been updated: Alicia Miller is the founder and managing director of Emergent Growth Advisors. Her Development Savvy column covers smart ways to market and grow a franchise. She is also the author of the forthcoming book, “Big Money in Franchising: Scaling Your Enterprise in the Era of Private Equity.” Reach her at amiller@emergentgrowthadvisors.com.