What is the Item 19 and How Do You Create the Item 19 in the Franchise Disclosure Document (FDD)

by FMS Franchise July 31, 2024 | Articles

7 minutes

Item 19 of the Franchise Disclosure Document (FDD) is a critical component for both franchisors and prospective franchisees. It provides prospective franchisees with financial performance representations (FPR) of the franchise, which can significantly influence their decision to invest. Creating a compliant and accurate Item 19 is essential for franchisors. This guide outlines what Item 19 entails, the rules surrounding its creation, and how to structure it legally.

What is Item 19?

Item 19 in the FDD allows franchisors to provide prospective franchisees with information about the financial performance of existing franchise units. This section can include data on sales, expenses, and profits. The primary purpose is to give potential franchisees a realistic understanding of what they might expect financially if they invest in the franchise. The Item 19 is one of the most critical and most litigated elements of a franchise agreement. It is extremely important that you not only take your time to carefully craft your Item 19, but also that you have legal guidance in finalizing this portion of your FDD.

The Importance of Item 19

Informed Decision-Making: The Item 19 helps prospective franchisees make informed decisions by providing them with a clear picture of the potential financial outcomes.
Competitive Advantage: A well-prepared Item 19 can make a franchise more attractive to potential franchisees compared to those that do not provide financial performance representations.
Transparency and Trust: Providing financial performance data demonstrates transparency and builds trust between the franchisor and prospective franchisees.

Rules and Regulations Surrounding Item 19

Creating an Item 19 involves adhering to specific rules and regulations to ensure accuracy, transparency, and compliance with the Federal Trade Commission (FTC) guidelines. Here are the key regulations:

Voluntary Disclosure: Including an Item 19 in the FDD is not mandatory. However, if a franchisor chooses to provide financial performance representations, they must comply with FTC regulations. It’s particularly helpful if you’re going to be running ads about your franchise opportunities as the content in the ads must mirror what’s in the Item 19.
Accuracy and Substantiation: Any financial performance representations included in Item 19 must be accurate and based on factual data. Franchisors must have written substantiation for all claims made, which should be available for inspection by prospective franchisees and regulators.
Consistent Presentation: The information must be presented in a clear and consistent manner. This means using the same criteria for measuring performance across all data points.
Historical Data: An Item 19 should include historical data from existing franchise units. This data can cover sales, gross revenues, average performance, median performance, and other relevant financial metrics.
Disclosure of Material Factors: Franchisors must disclose any material factors that may affect the data presented in Item 19. This includes unusual or non-recurring events, significant economic changes, or variations in franchisee operations.
Cautions and Explanations: Franchisors must include cautionary statements and explanations to help prospective franchisees understand the limitations and context of the financial data presented.
Legal Review: It is crucial for franchisors to have an Item 19 reviewed by a legal expert specializing in franchise law to ensure compliance with all regulatory requirements.

Structuring Item 19 in the FDD

Creating a legally compliant and effective Item 19 involves several steps:

Gathering Data
- Collect Financial Data: Gather accurate financial data from existing franchise units. This can include gross sales, net sales, average sales, profit margins, and other relevant financial metrics.
- Ensure Accuracy: Verify the accuracy of the data collected. This may involve auditing financial statements and records of franchise units.
Selecting the Data to Include
- Relevance and Clarity: Choose data that is most relevant to prospective franchisees. Ensure the information is clear and easy to understand.
- Different Metrics: Consider including various financial metrics, such as average gross sales, median gross sales, high and low sales ranges, and typical profit margins.
Analyzing the Data
- Consistency: Ensure that the data is consistent across all franchise units included in the analysis. This helps in presenting a reliable and accurate representation of financial performance.
- Substantiation: Maintain written substantiation for all data and claims made in an Item 19. This documentation should be readily available for inspection.
Drafting the Item 19
- Introduction and Overview: Start with an introduction that explains the purpose of the Item 19 and the type of data being presented.
- Financial Metrics: Present the selected financial metrics in a clear and organized manner. Use tables, charts, and graphs to improve readability and comprehension.
- Explanatory Notes: Include explanatory notes and disclaimers to provide context and clarify any assumptions or limitations in the data.
- Cautionary Statements: Add cautionary statements to inform prospective franchisees about the potential instability in financial performance and the factors that could influence it. Read more on Item 19s here: https://www.fmsfranchise.com/item-19/
Legal Review and Compliance
- Consult Legal Experts: Have the Item 19 draft reviewed by legal experts specializing in franchise law. They will ensure that the content complies with FTC regulations and accurately represents the financial performance data.
- Update Regularly: Regularly update the Item 19 to reflect the most current and accurate financial data. This ensures ongoing compliance and transparency.

Best Practices for Creating Item 19

Transparency and Honesty
- Accurate Data: Only include data that is accurate and can be substantiated. Avoid making exaggerated or misleading claims.
- Full Disclosure: Provide full disclosure of any factors that could affect the financial performance data, including seasonal variations, market conditions, and differences in franchisee operations.
Clarity and Simplicity
- Easy-to-Understand Language: Use clear and simple language to present the financial data. Avoid jargon and technical terms that may confuse prospective franchisees.
- Visual Aids: Utilize visual aids, such as charts and graphs, to make complex financial information more accessible and understandable.
Contextual Information
- Provide Context: Offer context for the financial data, explaining how the numbers were gathered and what they represent. This helps prospective franchisees make informed decisions.
- Benchmark Comparisons: Include benchmark comparisons to industry standards or similar franchise systems. This provides prospective franchisees with a reference point for evaluating the financial performance data.
Regular Updates
- Keep Data Current: Regularly update Item 19 to ensure that the financial data reflects the most recent performance of franchise units. Outdated information can be misleading and may result in non-compliance.
- Monitor Changes: Monitor any changes in the business environment or regulatory landscape that may impact the financial performance data. Make necessary adjustments to Item 19 to maintain accuracy and compliance.

Examples of Effective Item 19 Presentations

McDonald’s
- Comprehensive Data: McDonald’s provides comprehensive financial performance data in Item 19, including average annual gross sales for different types of franchise units (e.g., traditional locations, satellite locations).
- Detailed Explanations: The company includes detailed explanations of the data, providing context for prospective franchisees to understand the factors influencing performance. Read more on McDonald’s.
Subway
- Clear Metrics: Subway presents clear and concise financial metrics, such as average gross sales, median gross sales, and high and low sales ranges for franchise units.
- Visual Aids: The company uses tables and charts to present the data, making it easy for prospective franchisees to compare and analyze the information.
7-Eleven
- Benchmark Comparisons: 7-Eleven includes benchmark comparisons to industry standards, helping prospective franchisees understand how the financial performance of franchise units compares to similar businesses.
- Cautionary Statements: The company provides comprehensive cautionary statements, highlighting potential risks and factors that could affect financial performance.

Creating an effective and compliant Item 19 in the Franchise Disclosure Document is essential for attracting prospective franchisees and ensuring transparency in the franchising process. By following the rules and regulations set forth by the FTC, gathering accurate and relevant data, and presenting it in a clear and understandable manner, franchisors can provide valuable financial performance representations that aid prospective franchisees in making informed decisions. Regular updates and thorough legal reviews are crucial to maintaining compliance and credibility in the competitive franchise industry. For more information on how to create your Franchise Item 19, contact FMS Franchise or call us on 866-303-5761.