Deciphering The Franchise Disclosure Document

Speaker A: Foreign to go into business for yourself. Get ready for another episode of the Franchise Academy podcast. Ah, education, insight and inspiration. Here's your host, small business and franchise expert Tom Scara.

Speaker B: Welcome to another episode of the Franchise Academy. My name is Tom Scarta, franchise advisor and coach. I match people with franchise opportunities based on their skills, their personality, their goals. Like the eharmony of business is what a lot of people call it. And so I work with folks who are frustrated with their career, people that got laid off and they don't want to go back to the corporate rat race. I also help people that have a job, they like it, but they want to build something on the side, extra income. Today we're going to talk about knowing your numbers in franchising. I have one of the preeminent, most famous guys in accounting franchising. My friend Michael Ianuzi is from Citron Cooperman and we're going to talk down and dirty numbers about franchising. Everything that you need to know, things that you didn't know you needed to know, we're going to talk about it all. Michael, welcome to the podcast.

Speaker A: Tom, um, thank you so much for having me. It's been a long time and I can't believe we know each other for 20 years already.

Speaker B: This is 20 years.

Speaker A: It is.

Speaker B: This is 20 years. Like if you go back to my YouTube channel, like if you're listening to this, I have a YouTube channel with 200 videos on it. If you go back, the first video I ever did was with Michael talking about the FDD and how to read an fdd and you could tell it's really old because I had no gray hair whatsoever. So it was a different time. But not much has changed in franchising in 20 years, I have to say.

Speaker A: Uh, it hasn't actually. That's the funny thing.

Speaker B: But we've learned a lot.

Speaker A: Yes.

Speaker B: And it's one thing, oh my goodness, have we learned a lot in 20 years. Give us a little background who you are, give us your quick bio. Sure.

Speaker A: So, yeah, take a couple of minutes. Yeah. Again, thank you, Tom. Like Tom said, I'm, um, Michael Iannuzi and I co lead Citron Cooperman's franchise accounting and consulting practice. Been here at the firm for about 20 years now. Started as a staff person and made my way up through partner and then co chair of the practice. So the firm does a whole lot of things in the franchise industry for franchisors and multi unit franchisees. We do all the financial statement audit work for the franchisors that they have to put those into the fdd. A lot of tax planning, consulting, budgeting, due diligence for people buying and selling large blocks of multi units or franchisors, quality of earnings reports, valuation, expert testimony. Up until recently, been doing some extra advisory stuff. Through the growth of our firm, we've acquired a lot of advisory companies. So now we're doing software implementation to automate your budgeting, reporting power, BI reporting, dashboarding, and things like that. So been a very cool journey over the last 20 years, and we have a very good team of certified franchise executives, and I'm excited to see where the future goes.

Speaker B: Yeah, you guys are doing amazing. When we first met, obviously you were like, probably right out of college at the time. And the firm was young.

Speaker A: Yes.

Speaker B: Very young. And now look at you guys. 4,000 people. And so a big part of the whole franchise world is a franchise disclosure document, which we'll get into in depth in a minute. But I want to talk about audited statements.

Speaker A: Okay.

Speaker B: Right. The Federal Trade Commission oversees.

Speaker A: Everybody's going to drop off map.

Speaker B: What's that?

Speaker A: Everybody's going to drop off the call. Now that we're talking about financial statement, the amount of documents.

Speaker B: Oh, my God, no. And I'm not a numbers guy either.

Speaker A: Okay.

Speaker B: I became a numbers guy once I got into business.

Speaker A: Okay.

Speaker B: But the Federal Trade Commission oversees franchising as an industry. They mandate that every franchise has audited statements. Talk a little bit about that for a second.

Speaker A: Sure. So the Federal Trade Commission, which governs franchising and requires you to do the FDD and the 21 items that go into the FDD, also requires that the franchisor must have a set of audited financial statements. And what that is, when you think about the FDD and the amount of documents that you are given as a potential franchisee, you're looking to buy between the fdd, the franchise agreement, and all the other agreements that are in there. The audited financial statement is the only thing in that entire package that's independently verified by a third party, such as a firm like ours, where we're taking the franchisor's financial information, the balance sheet, P and L cash flow, and all the footnotes that go to the financial statement. And we're actually performing audited procedures where we're vouching and testing all these transactions to make sure that the numbers that the franchisor is reporting are fair and accurate. We then, with the company, put together the financial statements after everything's done and we conclude all our testing and we're in agreement with the company, their numbers. We actually issued a certified opinion, and that's why CPA has become CP CPAs, because we actually sign an opinion to those financial statements concluding on them, and then the franchisor will submit those with their FDD filing to the various state registration offices. So the financials are very important. It gives the health of the franchisor. But, uh, remember, it's at a point in time, so it's at 1231, 24, 1231, 25. Maybe it's June 30th. Different year ends depending on the franchisor. So a lot goes on from when that financial statement is issued to when you're talking to somebody like Tom three, four months later. Those are almost old already. So you want to really do your due diligence with Tom and your consultants to understand, has anything changed since those financial statements were issued? And those are things you're allowed to do as a potential franchisee. You're allowed to ask the franchisor questions, right?

Speaker B: That is right. Yeah. It's a mutual agreement between the buyer and the franchise company. So the audited statements, uh. That's a cool way that you said. It's the only thing that's independently verified. That's awesome. I love that you said that. The other thing you said was that in the FTD, there's 21 items. I usually say 23. So I'm just curious. 23.

Speaker A: Yep. I left five at 23. Good catch.

Speaker B: I was wondering if you just left off to mel. No, just 23.

Speaker A: Good catch there.

Speaker B: No, it was cool. It's cool. I just. Because I was like, I know Michael knows more than me. I just want to say, well, no,

Speaker A: I don't know more than you, but it was.

Speaker B: That's cool. So the order statements. Now, I don't want to get confusing here for people that don't understand the FTD yet, because they might be listening to this first time, but there's 23 different items that every franchise has to comment on. The 19th item is where they're permitted to put in average earnings of their franchise, uh, across country. That is not mandated, by the way. And. Yes, correct. So you don't have to put it in as a franchisor, which there's all reasons why people wouldn't. But is that connected to the order statements that you just mentioned, or is that just totally separate?

Speaker A: Totally great question. And totally separate. So the item 19, which is the financial performance representation disclosure, is an interesting disclosure. I would say the trend over the last probably seven to 10 years is that more franchisors are including what they would call an item 19 as opposed to prior, where less we're putting it in what the item 19 is a compilation accumulation of data from all of your active franchisees. For the franchisor that are currently in this now, there are no set rules of how you have to present it, but there are set rules on what you're disclosing and what I mean by that. Those are more legal in nature. Whereas if you have a hundred franchisees, you can't just put in 20 because those are your 20 best franchisees that ah, put their data in. You have to have set criteria as to why you're including and excluding certain people. And that information that the franchisor is putting in there must be readily available. So if somebody challenges it later on, they're not going out saying, oh, let me go get it. They have to have that prepared and ready to go when it's presented in the fdd. And Tom, to your question, when they're separate, the financial statements where the audit takes place is the franchisors financial information. That's it. The item 19 is the accumulation of franchisee data, of franchisees in the system. And so you can put in average revenue per franchisee, average cost of goods sold. If you're a service business, number of people you service per hour. If you're a barber, you know how many chairs you have in the barbershop and each barbershop does an average of five haircuts an hour. You can do all different things like that to get creative with it, but you have to be very clear and concise on the written part of what's in there, why it's in there, who got excluded. Be very careful compiling that information. And if you're reading, you have to make sure you're really reading and understanding what's in there.

Speaker B: Yeah, no question about it. And so it's just usually top line numbers. I like the way a lot of companies do it. I'll say McDonald's as an example. They give you. They bunch it into three bunches, right? The lowest earners, the middle earners and the highest earners. So you know where you know what you're looking at and I think that's helpful. Is there any sort of questions in your mind that somebody buying a franchise should ask the franchisor regarding their item 19 that would.

Speaker A: Yeah, you could ask. If you're not totally understanding how the information was gathered, really let them explain to you how they gathered this information. Are they. Did they use all the markets of where all their franchisees were currently operating? Why did they exclude certain people? And in your. You have to be careful what the franchisor says to the franchisee. But if it's in the item 19, there's. There's more questions and answers that can be, that can take place during that process. So if you're in a certain market, maybe you're going into a new market that's not in the item 19. And so you want to really understand if you're buying this system based on the item 19, but there's no units in your market, do you think you can hit those numbers? And you want to start to get a dialogue like that and maybe do more research on your end as the potential franchisee if you're going to some of these newer markets that are not currently disclosed in the Item.

Speaker B: I beautifully said you're right about that. And then it also rang a bell in my head. Same thing for the item 7, which is how much it cost to open the franchise. Right. I remember getting burned myself personally when I was the first one to open a franchise in New York and the franchise company was based in Fort Worth, Texas. Uh oh, it's only going to cost X amount. And it ended up costing double in New York. Yeah, but didn't see that coming. But yeah, this is kind of.

Speaker A: Kevin. Yeah, that's an interesting one too, because where I live in New York, same thing. Things are just more expensive, more permitting in certain places if you're doing brick and mortar. So even though there's a range of costs, the high end and the low end in the item seven, take some of that with a grain of salt and just make sure that you know what it's going to cost in your market.

Speaker B: Yes.

Speaker A: Do that research up front.

Speaker B: Amen to that. So item. The item 19. Back to that. So the earnings information. So typically I'll see, because I work with a lot of emerging newer franchises and they'll say we have 33 units, but there's only 12 here in the item 19 because the other ones have not been open more than a year. Is that kosher in your book?

Speaker A: So that's more of a legal determination. But as that's where I was saying earlier with the disclosure, the disclosure of how the item 19 is populated is key. So again, that FDD is at a point in time. So if you received it in April or May, but you're not signing until October, go back and ask if there's any updated information or if fdd was amended and there's more current data in there. This way you can continue your research. Because it's the data is only. Again, it's only when that document was published. It's not a live static update.

Speaker B: Uh, and maybe it should be, but I don't want to give you more work.

Speaker A: Maybe with AI in the future, all these things will live and breathe on our website, where it's just refreshing.

Speaker B: Yeah, and that's what went through my head when I said that. But I haven't seen it happening anytime soon. Okay, we'll keep an eye out for that update. So, yeah, that's interesting. And sometimes I see, I don't love it. But they'll say, here's our idle 19. It's only company owned stores,

Speaker A: that is permissible. But it should be similar to the franchise that's being offered. So if you're doing a gym concept and um, your company on locations, 25,000 square feet, but the franchise being offered is only 5 or 10, not really comparable. So again, when you're reading item 19 is not audited. Right. Nothing in the FTD besides the financial statements is independently verified. So as the reader or the buyer of that FTD or that concept, you have to do your own due diligence to make sure that uh, everything that you're reading makes sense to you as the buyer of that unit. And even if things maybe seem a little off to you, doesn't make sense for where you're putting your unit, can you make it work? Even if you think the estimated cost of investment as an example, is too low in the ftd, but you know what it really costs in your market, can you still make the numbers work for you?

Speaker B: Got it. So here's a dangerous question, but I feel compelled to ask it. So if nothing is verified in the ftd, is there any value to it?

Speaker A: Totally dangerous question. I do think there is a lot of value because those 23 items are important items. They've been around for a very long time. They do, there are supposed to be and there are very smart people in franchising on the franchisor side, franchisee side, supplier side, uh, consultant side, that are making sure that a lot of the rules are being followed. But it's like anything else, it's an investment. Right? You buy a stock in the market, you don't know what happens tomorrow. So you don't just want to blindly buy a stock. Same thing you don't want to buy, blindly buy a franchise. You want to make sure you do your research and look up the stuff that's in cd.

Speaker B: I agree. Stated. You could run for a politician after that. No, that was good because you're exactly right. And then what I say is the great thing about this, better than even buying a stock or as far as any investment I could think of, is the most transparent thing you could do because you could talk to the end user, meeting the franchise owners in that company. Great point. So that, that's where it all comes together. So it's Joe in Cincinnati. I'm opening up in New York. So like it says here, the average earnings is X. How do you feel? And that person has no vested interest on whether you buy or not. The reason he's talking to you is just to make sure that you're not a numbskull. And because his investment as a franchise owner is only as good as the weakest franchise owner in the company. So that's why when I was a franchise owner, I would always do the validation calls. I would always, because I wanted to, and I would report back to the franchise or especially if it was somebody who was like, sound sounded like a numbskull. Um, maybe you don't want to offer this guy a franchise because it does, it's not going to be good.

Speaker A: And Tom, all that data is in the ftd, right? All the, the current and closed franchisees, their phone numbers, locations. That's all in the back of the fdd. So the franchisor may give you a few people to call, but you have the list of everybody. So call everybody. Call the closed ones, call the ones that didn't open yet. Call the ones that have been open for 20 years. Call as many people as possible. Go visit some of them if you can.

Speaker B: As many as you can. As many. I often tell people what's cool is if a lot of people like, oh, I want to be the first one in my market. And I'm like, um, maybe not the best thing to do. I like when there's somebody already there. And so they already started blazing the trail. And we know that the state has accepted the FDD and all that kind of stuff. But also more than that, you could go and spend day shadowing the franchise. And I did that many times with my smoothie franchise. People would come and they would hang out with me for a day and I would show them the good, the bad and the ugly. And, uh, I would want them to buy because it expanded the brand, which expanded my equity in the brand. So that was all good. But if I had somebody who came in and started saying Things like in the smoothie that I. In a smoothie franchise I had. The thing was, you had to buy the smoothie mix. You didn't buy it from them. That was a cardinal thing. If they're saying stuff like, can I get this stuff cheaper? That's a red flag because you don't want to circumvent the franchise there and still be selling some subpar smoothies. So that's really cool. So as somebody listening in right now and they're thinking about a franchise that might have an FTD in their hand right now, what's advice that you would give to them about the ftd?

Speaker A: Read it like thoroughly. Know it gets skimmed through. I know things get passed, uh, up on. Read the fdd, maybe not do it all in one sitting if you can't get through, but do it in a couple of sittings. Go through all the attachments that are in there, the exhibits, go through all of that stuff and write down your list of questions that you have. And especially on the financial statement side, when you're going through the financials, if you see things that look a little weird, like maybe the company's operating at a deficit or at a loss, there many reasons for that and some are good. That's just the way the accounting works. And so there's a loss instead of a profit. But those are all things that you can ask the franchisor to get a good understanding as to what's going on. And then having people like Tom or a good franchise attorney to go through those agreements to make sure that what you're signing is something that you're comfortable with. And just do your due diligence and don't rush. But look, nothing's perfect. We know businesses are going to fail. Like, you just know that's going to happen. So do your best to be thorough to make sure that's not something that happens to you.

Speaker B: So you just said a lot of gold right there. That was really great stuff and great advice. And first, I want to say that what I have is what I call a FDD cheat sheet. And all it is, uh, a, uh, one sheet that tells you what each of the 23 items are and what to look for. So if somebody's listening to this and they need that, just email me at Tom atthe franchise academy.com I'll get that to you. Also, we also we talked about talking to franchise owners. I have 39 questions to make those calls really effective. So I've been doing this for 20 years and I've owned and Operated my own franchises prior to this. And so I got a great list of questions that I would be happy to give to you again. Just email me at tom@the franchiseacademy.com so I'm looking at my franchise and I'm listening. And they're listening to us right now. Should somebody reach out to your firm to get an audit or. This is what we talked about before we went on am. But should they call you to review the numbers so we can look at

Speaker A: the FTB and provide some general commentary and feedback on the financials and certain things that are in there to make sure they're matching up? If the financials say 10,000 was spent on grant fund expenses, the FTP kind of has that information in there as well. So we can go through things like that for you if you'd like. We cannot, we're not brokers or anything like that. So we can't tell you if this is a good investment or if you should buy the unit. We do get that question a lot. So we always let everybody know that is something where we can't do. If you're going for a bigger purchase, let's call it 10, 15 units of an existing business, that is something that you may want what's called a quality of earnings report or some sort of due diligence, financial due diligence tax, due diligence. That is absolutely something that we do multiple times throughout the year. So there are things, when you make a purchase of an existing business that you may structure it as what's called an asset sale. Still, potentially some liabilities, though, can make their way through even, uh, asset sale. So those are the types of things that we would look at up front, what you're getting into. And maybe there's some sales tax. That's an example of 1 sales tax liabilities make their way through the asset purchase to the new buyer. So you're going to want to know if any of those things are out there and outstanding.

Speaker B: Yeah, great. And that's good. I didn't even put it together like that in my head. So that's. The resale thing is a whole nother animal. Um, and if you're buying a bigger asset, like you said, multi dozens of units and stuff, you definitely need to go through that work. And a great franchise attorney of great help. I know several, either Michael or Iker refer you to some great attorneys. It's important to have that looked at. Just. And by the way, just like you said, the attorney's not going to say, oh, this is A great franchise. You should buy it. They're going to say, look, this is what you're signing. Are, uh, you okay with this?

Speaker A: Yes.

Speaker B: That's what you want the attorney for. No one's ever going to tell you that it's a good business, because if they're a professional and you do good, they get nothing out of it. If you fail, it could be a legal problem down the road if they said, buy this franchise. So, uh, m. That's a problem. So you have to do your due diligence, but it is the most transparent investment you could make. No doubt about it regarding FD and all this finance stuff. But in the fdd, everything could be verified through the franchise owners, right? Not just the company. Don't rely just on the company, and don't rely just on the fdd. Would you agree with that?

Speaker A: I would agree. And, Tom, you've been doing this a long time. Like when you call other franchisees, and in general, the franchise professional as a profession, as a whole in the industry, people are very friendly and they help each other out. So when you make those calls, you're getting, I would assume you're getting the data that you need. Um.

Speaker B: Oh, yeah. And that's the beautiful thing. People like, oh, why did. Why would they want to take the time out of the day? For the reason I said earlier, because they want to make sure that good franchise owners are coming in to their business. It's like a family and a good franchise. There's a lot of franchises out there that are like, weirdo. They just. They only care about Your store number 2645. Did you pay royalties? They don't know anything else about you, and that's not good. But the franchises that I like, it's a family feel. And you will get the data, they'll share it with you because they want to grow the brand because it grows their equity. When the tide rises, all the boats float. And the other thing, the other point I like to make about all of that is get your head out of the corporate space. There's no one here that wants to stab you in the back and take your position in franchising. Everybody does well, and they want you to do well because everybody does better. If everybody does well, it's a, uh, symbiotic relationship. It's way different than corporate America. And that's the reason many people go into franchising.

Speaker A: All the events that take place, the conferences, is you can go to a conference every month, twice a month if you wanted to. They're all A lot of them are education. Then there's selling shows, networking franchise shows. You can really immerse yourself into this as the ifa, which is the International branches Association, which we're supporters, supporters of. So you can really get involved. And at these conferences, competing franchisors are on panels together sharing best practices. So that is how this community. I find it a community. This is how it is.

Speaker B: Yeah. No question it's a community. It's a family feel. I have. I'm not naming franchise companies, but I've seen McDonald's sit down with Burger King and have really uh, great discuss discussions about the good, bad and ugly and fast food burger industry. It's, it's really an amazing thing. And the IFA is phenomenal. You could go to franchise.org and check out the International Franchise Association. A wealth of information on there. Really great stuff. And lastly, we'll wrap this up. I wanted to get you had mentioned CFE at the beginning of this. We're both CFEs. Instead of me explaining it, I'd like to hear your version of what a CFE is.

Speaker A: Sure. So CFE is Certified Franchise Executive. The IFA has a curriculum geared around this where it's various educational webinars. You have to attend certain conferences, certain live classes, on demand classes, things like that. And it's really to give you an overall general education on uh, franchising, legal, accounting, business development, franchise sales, all the big topics that go on in franchising. After you complete the curriculum, you graduate at the IFA convention and then you get your CFE designation, which I think you have to renew every three years, I believe it is. And you become part of the franchise community with other CFEs. It's a great way to really meet each other. Network. Some of my contacts that I know for years I met at the CFE program and we kind of came up together and now, uh, we do business together.

Speaker B: Yeah, me too. It's great. We probably met. I know we definitely were at the IFAs together. But there's a lot of people and a lot of fond memories and it's always in great cities and there's so, just so much education. So uh, definitely promote that. I'm a big supporter of that myself. Michael, I want to thank you for taking your time out of your day and you guys are busy. We had to wait to get f post still to get you on here. So I appreciate it.

Speaker A: Thank you. This is great. I really enjoy doing this stuff.

Speaker B: Yeah, I count you as a great friend and I really appreciate your time. And I will see you at an International Franchise association conference soon.

Speaker A: Absolutely. Thank you.

Speaker B: Have a great one.

Speaker A: You too.

Speaker B: This has been another episode of the Franchise Academy podcast. For more info, go to our website, thefranchiseacademypodcast.com Remember to subscribe to Tom Scarda's YouTube channel for educational videos on franchising, education, insight and inspiration.