Spotting What You Need In Financials-Sold But Unopened Store Revenue
This is an example of only one of the many things you need to be able to spot when you are thinking of buying a franchise and are handed an FDD document with the franchisor’s financial statements attached as an exhibit.
What the franchisor wants you to focus upon is whatever the positive signs may be, especially year to year stability and growth in its financial condition. But is it real?
For one thing, it is presented on an accrual accounting basis. What does that mean? What are the implications of that fact, standing alone, upon the reliability of the financial statements? What do you have to look for to find out? Where should that information be located? If you don’t know what it is and where it should be, how will you know to ask about it, or what to ask for?
Are there special accounting rules for franchisors? What are they? Are they being complied with in the financial statements you are holding in your hands? How can you tell? Where do you look for it? If it isn’t there, do you know what to ask for?
The list of whistle stops as you travel through the FDD is a long list. This is just a peek at one of them.
There is a long tenured problem in franchising that identifies franchisors that are not investment worthy. Actually there are many such problems, but we are only talking about one of them right now. That is the SOLD BUT UNOPENED stores problem. Some franchisors sell more franchises than they are capable of bringing along through training and store opening support. If you knew to ask about that and you did ask – Please tell me how many franchises are sold but not yet open? How long has the longest been waiting for opening after signing the franchise agreement? – the response would probably be a “how dare you ask me such a question” answer or a statement showing that sold but unopened is not a problem for that franchisor – assuming the answer is truthful. You can’t usually test the FDD for the truthfulness of the statement if the franchisor you are looking at is violating the accounting rules.
The AICPA accounting rules for franchisors call for segregation of revenue from initial franchise fees until the store is up and running. Only franchise sales revenue from stores open and operating should be included in the general statement of gross sales. In franchise registration states where there is some review of the registered materials, a thinly capitalized franchisor will be required to place initial fees revenue into an escrow account until the franchisee is up and running and signs a release of funds statement acknowledging that he has received the promised initial support needed to get up and running. This phenomenon is that important. This isn’t nit picking here. If it is included in gross sales – as it almost always is – there should be a footnote by the gross sales entry in the financial statement that takes you to a note to the financial statement showing the amount of initial fees income that is attributable to sold but unopened franchises. Expect that you will not see compliance with that protocol in any company that is having the problem. They don’t want you to know that when you sign the franchise agreement you only get to stand in a long line of suckers who are waiting many months – or longer – to receive training, site location assistance (an unreliable promise and representation in almost every instance), store build out and grand opening assistance.
I have seen this phenomenon dozens of times in my practice over the years. In one instance, the most outrageous I have ever heard of – if the accusations are true – Quiznos in being sued for having over 3,000 sold but unopened franchises. I don’t know the truth of the matter as a matter of my own knowledge, but if it isn’t a responsible allegation the lawyer who brought the suit can expect a lot of trouble from the judge – maybe even an attack on his license to practice law. And yet Quiznos continues to advertise for new franchisees, despite that problem and the many other Quiznos problems that are catalogued by those claiming to be aggrieved on www.BlueMauMau.org. People attend Quiznos franchise “fairs” hoping to become a “lucky” Quiznos franchisee making the enormous profits and investment returns that the ignorant think Quiznos franchisees earn.
Evidence that some of my most FranWhack, unworthy of investment, companies, are doing this may be seen in this week’s Nations Restaurant News (Vol 42 No 46), that reports on the front page that Cold Stone Creamery and others “sought profits as usual by signing up new franchisees”. What does that tell you? It tells you that a company that has to keep selling franchisees to keep its earnings on line isn’t generating earnings from operations sufficient to keep earnings on line.
The message from such really stupid revelations (the people from those companies who said such things will probably get slapped hard for their big mouths) is that they are engaging in accounting slight of hand in their financial statements and that they are certainly not saying to franchise investment prospects what the truth is about profits from operations. The truth may be buried somewhere in their financial statements, and maybe not. But the important thing is that such companies are not investment worthy. Intelligent, well informed franchise investors will not buy their franchises. Only suckers will buy their franchises, and they will appear on www.BlueMauMau.org lamenting how they got ripped off, joining the other franchisees of these companies in their weekly dirge about their lousy franchisors.
There are many articles on www.FranchiseRemedies.com about franchise fraud. They are all available without charge. Read them. Send them to your lawyer or whoever else is advising you about investing in a franchise opportunity. Don’t do this with everything you have accumulated in this world without becoming well informed.