Note to Restaurant Investors and Franchisees

Lately, there has been a spate of restaurant franchisors in heavy sales mode, pushing their concepts with little to no disclosure of sales or profitability. I have seen four concepts of late: a better burger franchisor (50 units), a frozen yogurt franchisor (300 units), a french fry only snack kiosk operator (14 units open), and the other a better burger concept (2 units open).

Two of these concepts presented at the recent ICRX Exchange Investor Conference, where all the financial and money people in the room weren’t impressed when they wouldn’t talk numbers.

None of the four franchisors makes so called financial performance disclosure. Zero, nada, nicht. All of them have practically no operating history. So what could they put in the Franchise Disclosure Document (FDD)?

There’s been discussion for years how effective the Franchise Disclosure Document really is. It is presale disclosure, and is in no way representative of what can happen over history. Talk to the old time Wendy’s, McDonald’s and Burger King franchisees, prior to the late 1990s. No one could have imagined selling a dollar menu then with the vigor it is today.

The FDD is a horse put together by a committee in 1979 resulting from the SBA franchising frauds in the mid 1970s. There is no called required financial performance representation at all, but rather, if any is used it must be truthful. Only a few brands in the restaurant space break out store level financial performance into ranges or bands of performance. Many just list gross sales averages. To be clear, gross sales are NOT “what can you make”, what you can make is store cash flow after debt service, taxes and capital expenditures (big ticket items).

It is often noted that an attorney or accountant should be consulted. Unless they have strong business sector familiarity, they might be only able to tell you how tight is the franchise agreement. Find the real experts, those who specialize in franchising.

A few factors of note can be seen from the FDD. You have to look very closely. For young brands with no history, there are just a few things that are seeable.  Start with one: look at the founders and current management. Do they seem like they know what they are doing?

Sales isn’t profit, and profit isn’t free cash flow or money in the bank. Your business has to cover the rents and occupancy costs, the overhead, interest expense and principal loan repayments

For restaurants, keep in mind if numbers aren’t disclosed, that means something. Keep in mind that a lot of restaurant success is about expanding from a base geography. Very few restaurant chains even today are such global powerhouses that they have strong sales and identity everywhere.

The late Lewis M. Rudnick, attorney and founding father of what is now the DLA Piper franchisor practice, and founding father if there was one, of the International Franchise Association, the pro-franchisor lobby and political group, in a good paper in 1992, “Investigate before Investing,” noted that there was no reason to avoid small startup franchisors in limited territory, since they sometimes grew. They sometimes do grow, but it takes time.