What can I tell franchise buyers about projected income?

Most prospective franchisees wanting to buy a franchise will ask two main questions “how much will it cost me” and “how much will I make?”.

These are not unreasonable questions and sometimes franchisor answers such as “I have no idea”, “I can’t tell you anything”, “Do your own due diligence”, will cause a prospective franchisee to lose interest and look elsewhere. 

Therefore, there is always the temptation for a franchisor to make such sort of statement to a prospective franchisee about likely projected income. 

So, franchisors should ask themselves the following questions:

  • what can franchisors say?
  • how should they say it?
  • what are the risks?
  • is it worth it?

The starting point is the various laws that prohibit misleading and deceptive conduct in trade and commerce, for example the Australian Consumer Law (ACL). A violation of these laws can expose a person to pecuniary penalties, but more importantly for the purposes of this article, civil liability to pay compensation to the party affected by the misleading and deceptive conduct. 

Franchisors must, therefore, be careful not to mislead and/or deceive prospective franchisees during the recruitment process.

To have a valid claim the affected party must prove that:

  • the complained about conduct occurred and was misleading and/or deceptive;
  • was relied upon by the affected party; and
  • caused loss

However, if the conduct amounted to a representation or statement about a future matter (such as an income projection), the ACL deems this to be misleading and/or deceptive, unless the person who made the representation or statement can prove that it was based upon reasonable grounds.

Therefore, the franchisor who wants to provide an income projection to a prospective franchisee must make sure that every figure in the projection is based upon reasonable grounds. 

So if a projected profit and loss statement or projected cash flow is given, there must be reasonable grounds to support the projected sales and every item of projected expenditure.

Franchisors should not guess at or pluck figures out of the air. If an income projection is given and is based upon the performance of other franchise businesses, there must be proper comparators.

Demographics, the type of location and shopping centre and levels of competition are a few of the sorts of factors that need to be considered. 

There must be serious economic science behind the projection.

It is also critical that the franchisor keep detailed records and supporting documents to evidence how it arrived at the projected figures. This documentation might be needed in Court one day or it may be required to answer an ACCC query or audit.

If a franchisor can prove the existence of reasonable grounds for the income projection, it will escape liability, even if the projected income did not come to pass.

The franchisor who wants to provide an income projection to a prospective franchisee, must also comply with the Franchising Code of Conduct by ensuring that Item 20.4 of its  disclosure document is completed. This item requires disclosure of:

  • the facts or assumptions on which the projection or forecast is based
  • the extent of enquiries and research undertaken by the franchisor and any other compiler of the projection or forecast
  • the period for which the projection or forecast relates
  • an explanation of the choice of the period covered by the projection or forecast
  • whether the projection or forecast includes depreciation, salary for the franchisee and the cost of servicing loans
  • assumptions about interest and tax

It is always prudent for a franchisor to heavily qualify any income projection.

The reality is that the franchisor does not know how the franchisee might perform, whether they may be affected by personal issues, whether new competition might come into the area, whether there might be a downturn in the economy or whether the brand or the products sold might be the subject of serious reputational damage (recent examples being 7-Eleven and VW). 

These types of disclaimers or qualifications do not provide automatic protection for franchisors but there have been cases where a well-drafted disclaimer has caused a Court to conclude that a prospective franchisee could not have relied upon the document in question.

Franchisors should also avoid giving any verbal income projections. If you do, you (and your franchisee) may be faced with the “he said, she said” dilemma and a Court may simply not accept your account of the conversation. 

It is better to confine everything to writing and to make sure the disclaimer and qualification forms part of the same document. Then there can be no doubt as to the content and terms of the income projection.

There isn’t any doubt that there is risk associated with giving an income projection.  Although a franchisor might think it has reasonable grounds upon which to base the income projection, the franchisee, or more importantly, a Court, may not agree.

Some franchisors merely give historical information (actual past sales results) thinking that this could not be misleading or deceptive.

But even this can be dangerous.

Even though the information provided might be factually accurate (i.e. there is no misrepresentation), one has to remember that the law focuses on conduct and if the conduct is misleading and/or deceptive there will be legal exposure. 

For example, providing to a prospective franchisee of a greenfield site in a strip location in Hobart the actual sales results for a site at large shopping centre in Melbourne, by itself, without any explanation of the differences between the two sites, might be misleading or deceptive. That is why item 20.2(b) of a disclosure document requires franchisors to explain such differences.

So, is it worth it? This is really a commercial decision that must be made by weighing up the benefits (achieving the sale of the franchise) against the cost of getting it wrong and the cost of doing the research to establish reasonable grounds. 

If you can sell the franchise without giving income projections, then there is no point providing them. But if you can’t sell the franchise without giving income projections, you really have no choice and in this case you must invest sufficient time and money in doing the research to establish reasonable grounds. 

In addition, it would be wise to insure against such claims. Franchisors need to factor these costs into their business planning and pricing.