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New guidance for franchisors reins in FPRs
By Beata Krakus, Leonard Vines on June 16, 2017 at 10:25 AM

Financial accounting and reporting documentsOn May 8, 2017, the North American Securities Administrators Association (NASAA) released its final commentary on financial performance representations (FPRs), providing franchisors with additional clarification and guidance on how to prepare one of the most important parts of their franchise disclosure documents (FDDs).

Preparing and sharing FPRs (formerly known as earnings claims) has long been a challenge for franchisors. Although franchisors are not required to prepare FPRs, information about earnings is often what a prospective franchisee wants the most. In recognition of that desire, it is estimated that 60 percent of franchisors include FPRs in their FDDs.

Before the commentary, the general rules have been just that – general – and there have been relatively few restrictions on how franchisors can shape and mold FPRs. At a basic level, the general rule is that franchisors cannot share FPRs with prospective franchisees outside of the franchisor’s franchise disclosure document. Also, a franchisor must have a “reasonable basis” for any FPR. Some guidance has been available from the FTC and NASAA, but it has been limited.

The new guidance in some ways restricts a franchisor’s ability to make FPRs, but it is intended to provide guidelines to help franchisors prepare FPRs that have a reasonable basis and are clear. For example, in an effort to clarify what constitutes a reasonable basis, the new commentary requires franchisors that choose to disclose top performers in the system to also disclose the worst performers. If a franchisor provides an average or mean number, they must also provide the median figure and vice versa. And, franchisors with operating franchisees will typically not be able to limit disclosure to the franchisor’s performance data. To make sure that relevant information isn’t lost, franchisors will also have to clarify what they mean by terms such as gross sales or net profits.

In some respects, having limited regulations of FPRs has been a good thing for franchisors. Franchises exist in a multitude of industries, and with each industry the financial model is a little different, as are key metrics of importance to prospective franchisees. Trying to fit FPRs for very different industries into one mold would be difficult, and franchisors have had (and will continue to have) some flexibility to express FPRs in a way that makes sense to their particular system.  On the other hand, with FDDs subject to state registrations, this relative freedom has also meant freedom for state regulators to comment on franchisors’ FPRs. Comments from states often post-date approval orders from other states, sometimes making it hard for franchisors to have a uniform multi-state FDD. From that perspective, the additional guidance from NASAA is welcome. The hope is that, with more specific rules, franchisors that carefully follow them will be able to avoid or minimize comments from state regulators. While it will likely take a little bit longer to prepare the FPR, it will hopefully cut back on the administrative difficulties with managing multiple FDDs or amending the FDD to make it consistent in all states. Of course, there is no definition of what constitutes a “reasonable basis,” and answering that question will remain subject to interpretation.

The new NASAA commentary becomes effective on the later of 180 days after the adoption by NASAA (Nov.4, 2017), and 120 days after the franchisor’s next fiscal year end, if the franchisor had an effective FDD as of May 8, 2017.

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