I continue with the second installment on Observations from the IFA Convention on the Ins and Outs of Financial Performance Representations (“FPRs”). Again, my thanks to Max Schott of Gray Plant Mooty for co-authoring this summary with me. We focus this time on new franchisees or acquisitions of a franchise system.
How does a start-up franchisor deal with FPRs? Obviously, a franchisor that is just beginning to offer franchises will not have any information from franchisees. As an alternative, the franchisor may be able to rely on information from existing company-owned units it or its affiliates operate to prepare an FPR. In such case, the franchisor must make sure to carefully describe the characteristics that will be different for a franchised unit, like the payment of royalty and advertising fees. While most franchise registration states will allow start-up franchisors to use FPRs based on existing company-owned units, some state examiners have taken issue with FPRs of this type if they do not believe the FPRs have a reasonable basis (i.e., there are not enough similarities between the existing company-owned units and the units franchisees will operate). In addition, once a franchisor has had franchised units open for a meaningful period of time (which may be as short as one full year), many of the franchise registration states will require the franchisor to include franchisee information in lieu of or in addition to information for company-owned units.
How does the acquisition of a franchise system impact a new franchisor’s use of an FPR prepared by the old franchisor? An interesting question posed by one of our attendees. Presumably, the new franchisor acquired the franchise system in an asset (and not a stock) deal. At a minimum, before continuing to use the information in the current FPR, the new franchisor will want to review it and receive written substantiation of it from the old franchisor. The franchisor will then want to do a cost/benefit analysis regarding the use of this information. As a best practice, however, the new franchisor may want to forego including an FPR in its FDD until it receives new information directly from franchisees or independently verifies the information in the current FPR.
Next up will be a few pointers on the preparation of FPRs.