What FranchNet Resources Look for When Evaluating Franchisor Financials in Item 19
What franchisor need to know before sending their FDD to a FranchNet Resources.
Most seasoned franchisors will tell you that the key to building a successful franchise system is selling franchises to qualified franchisee candidates- a process often made easier by working with franchise brokers.
Before reaching out to FranchNet Resources about offering franchise opportunities, franchisors need to make sure they’re in the right position to attract strong franchisee candidates. To do that, a good place to start is knowing what FranchNet Resources look for when evaluating the Franchise Disclosure Document (FDD) before connecting you with our network of prospective buyers.
Below, we’ll explore the key qualities that FranchNet Resources expect to find in a franchisor’s financials – especially when it comes to reviewing Item 19.
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A track record of success
Having an item 19 in the FDD is necessary for the majority of franchisors. Sometimes we’ll hear from a franchisor, ‘No, we don’t have an Item 19 because we’re too small, and we only have a corporate location.’ Both – you should still have an Item 19. We need something to go after. Even if it’s a fabulous P&L (profit and loss statement) of that corporate location, the franchisee candidates can use that.
Because Item 19 contains important information about the franchise system’s financial performance over time, we and the franchisee candidates work with its disclosures to make decisions about investing in a business – something we can’t do without numbers to review. Franchisee candidates need those expense items, those income items – where are we going to make money from – so they can come up with their own conclusions,”
For new brands and franchisors that don’t have many franchisees yet, we recommend working to provide as much financial information as possible within Item 19 for the sake of transparency. Even with newer or smaller brands, a skipped Item 19 can sometimes mean the difference between a broker choosing to work with your brand, or passing it by
For us, a new brand or not a ton of franchisee candidates and no Item 19 is like, okay, you sit on the bench until you have one – because there’s a million other franchisors like you, probably in the same category, that are going to give us that information.
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The Right Timing
Although franchising is a proven business model, it isn’t for everyone. Because prospective franchisees are looking for investment opportunities with franchise systems that exhibit a strong track record of financial success, the numbers in Item 19 can help candidates and brokers determine whether a business is in a position to succeed as a franchise.
Sometimes they could be developers that hadn’t explained the significance of financial disclosures; thus, a review of the company’s numbers could not be in a position to sell franchises yet – even though the owner could have franchised the business.
Instead, for businesses with financials that don’t stack up against franchise industry standards, its recommended that owners take time to build up their company’s numbers and pursue franchising later down the road when it’s more viable
If your numbers aren’t good enough, it doesn’t mean franchising isn’t in your future. But go make them good enough and don’t franchise just yet.
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Strong Unit-level Economics
Beyond a brand’s overall financial health, FranchNet Resources want to work with franchise systems that exhibit good unit-level economics – that is, each of their franchisees is performing well with numbers that can validate the franchisor.
To make sure unit-level economics are represented in the FDD, it is advised that franchisors provide franchisees with an easy method of keeping track of their numbers. One method seen used recently is a simple, pre-formatted spreadsheet. There are several franchisors right now that are sending those out blank as a ‘Unit Economics’ blank Excel spreadsheet, and then [franchisees] have to put the numbers in.
It’s also recommendable to making sure that franchisees include income from all revenue sources in their own categories, which can help identify the unit’s strengths and weaknesses during future evaluations. Further, franchisors need to make sure each franchisee understands how the data will help them improve their own business, in addition to the franchise system itself.
Franchisees don’t want to think that they’re just doing this new chart of accounts in order for the franchisor to make money. No, it’s by doing so to help them make more money and helping them make better business decisions. By breaking down the ways categorized data can help franchisees improve their own business models and identify opportunities for increased profits, financial tracking can become a valuable tool across the entire system.
Make it a franchisee-centric type of project in that all are going to get a more detailed P&L and a more detailed balance sheet to help you become better franchisees, better business owners but, that’s also going to help franchisors bring it full circle into validation, because now you have successful business owners who are validating to these candidates.
Because a properly-prepared FDD and detailed Item 19 is a franchisor’s ticket to attracting quality franchise brokers – and well-qualified franchisee candidates. It’s advisable for franchisors and franchisees to get familiar with their numbers and be prepared to discuss them with brokers and candidates throughout the entire year.
Validation calls are being recorded, and they’re going to be put into perpetuity. Make sure your franchisees know their numbers and the percentages, and what their business looks like on paper.
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Numbers that tell a Story
Beyond simply providing franchise brokers with pages of numbers, it’s important for the financial performance data in Item 19 to come together to tell a story about the brand itself – something brokers and candidates notice. Your Item 19 needs to fit in with a bigger story about the brand, the business model. That economic story is not how much money can I make, but what does it look and feel like? What are the revenue levers? What are the expense categories?
To make Item 19 financials more appealing to brokers during the evaluation process, it’s recommendable breaking revenue streams down and looking for stories within them that align with the brand, including its business model and services.
Before you even get past gross sales, evaluate if there’s a story there. Can we break up your revenue streams? For example, is a part of your revenue recurring revenue? And can you identify the recurring streams? Are there different service categories? Should you be identifying different service categories? I think that’s a very overlooked advantage that franchisors drop the ball on.
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Categorized Revenue Streams
It’s important to break revenue streams into categories, as stronger and weaker revenue streams. This may be helpful for brokers and franchisee candidates when evaluating the franchise’s financials.
If the business has three- or four-income streams, it’s great to list out those income streams. There is value in tracking revenue streams by category – a practice that can help brokers and candidates, as well as franchisors and franchisees, easily identify which parts of the business are more profitable. For businesses where revenue can’t be divided into categories, though, there are still options.
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Investment in Franchisees
Another quality FranchNet Resources look for when reviewing a franchisor’s financials is the support Franchisors provide to franchisees. Something that can build trust with franchisee candidates considering investing in the brand.
This is a new industry for some franchisee candidates. That’s why they’re choosing the franchise world, because they have someone that’s going to help them and hold their hand. So, show that from the very beginning – I’m going to help you, I’m going to help you get this going, I’m going to be with you, and then we’re going to work on scaling your business and you know, making you an empire.
Because the success of a franchisor rests on the success of their franchisees, FranchNet Resources tend to value franchisors that prioritize setting their franchisees up for success from the start by providing proper training, marketing, pre- and post-opening support and more.
From the beginning, you are showing what kind of franchisor you’re going to be. Are you going to be transparent? Are you going to be supportive? Are you going to help me with the details? Or are you going to give me a training manual, wish me luck, pat me on the back and I’ll call you in a month when my royalties are due?
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Validation
Because the purpose of the FDD is to provide franchisee candidates with enough information about a franchise system to weigh its potential benefits and risks, FranchNet Resources typically look for an Item 19 that is informative enough for candidates to draw their own conclusions about the brand.
The level of franchisee candidate questions is very business-oriented. So, they are asking, based on what they’re seeing in Item 19, for validation – they’re validating what they think they heard to what’s actually happening. And so, it’s important that franchisors take it all the way through the process, and that those franchisees also know their numbers.
To make sure a franchise’s Item 19 disclosures are thorough, its advisable that franchisors do a deeper dive into the company’s numbers to ensure they provide a realistic picture of the brand’s daily operations. The other point is a deeper dive in the data – not just through sales, but through sales breakdowns, different categories of revenue streams, types of customers, cost of goods sold. So, we have those drill-downs.
For new franchisors with few existing franchisees, FranchNet Resources won’t mind if Item 19 isn’t full – but it still needs to provide enough information for a candidate to work with.
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Accountability
In addition to complete, accurate numbers that tell a cohesive story, FranchNet Resources is also on the lookout for franchisors that take initiative – especially when it comes to meeting deadlines. Franchisors should take time to evaluate their numbers annually and make sure their FDD is renewed on time – a practice that can demonstrate a sincere commitment to accountability.