Each time franchisors update their franchise disclosure documents (“FDD”), they have a choice: whether or not to include financial performance representations (“FPR”). A new bill introduced by Representative Keith Ellison (D-MN) makes the choice much easier…by taking it away…at least for some franchisors. The SBA Franchise Loan Transparency Act of 2015 (the “Act”) would make certain types of FPR’s mandatory for franchise brands that qualify for SBA guaranteed lending for their franchisees. (We discussed Rep. Ellison’s sister effort, the Fair Franchise Act of 2015, in a recent blog.)
FPR’s are complex – we’ve done an entire series on them. But generally speaking a franchise seller makes a financial performance representation when it tells a prospective franchisee something about the franchise’s “actual or potential sales, income, gross profits, or net profits.” 16 C.F.R. 436.1(e). Three sections of the FTC’s Compliance Guide are dedicated to FPR’s, as are four FTC Rule FAQs. Drafting compliant FPR’s is a methodical task involving an iterative process between a franchisor and its counsel. In short, the decision whether to include FPR’s in an FDD, like so many business decisions, is a balance of pros and cons that is unique to each franchise system.
The reasons the Act mandates FPR’s is simple enough to understand: the Small Business Administration makes a lot of loans to franchisees ($10.6B from 2003-2012). Over that same 10 year period, the SBA paid out $1.5B in guarantee payments to franchisees. If franchisees had more accurate information regarding franchise revenues, the argument goes, they would be less likely to overleverage and therefore less likely to default. So why not require franchisors to furnish franchisees with this financial information?
And this is exactly what the Act would do. Most franchise brands that qualify for SBA guaranteed lending for their franchisees would be required to disclose the following in their FDDs:
- Year 1 average unit revenues for franchised units for the previous 5 years;
- Year 1 unit failures for franchised units for the previous 5 years; and
- Average unit revenues for all franchise units showing the average for the top 25%, middle 50%, and the bottom 25%.
Disclosing these items in an FDD would trigger application of federal FPR regulations and their extensive commentary. Whether the Act would decrease bad SBA loans is debatable. But it will undoubtedly increase the time, effort and cost of preparing FDD’s. It will exposed franchisors to unique risks that accompany FPR’s. And most importantly, it will take away a franchisor’s choice whether to incur these costs and risks.
The Act is far from becoming law. But it does highlight how easily good intentions lead to unintended consequences–especially in an already heavily regulated industry like franchising.