Insights & Articles
Franchise Canada – Why is the Franchisor so Tight Lipped About Earnings
Q: Why is the franchisor so reserved about earnings?
A: Prospective franchisees often find that even after researching the franchise system, engaging in discussions with the franchisor, and reviewing the franchisor’s disclosure document, earning potential remains unclear. While franchisors generally want to provide earnings-related information to prospective franchisees, statutory disclosure obligations and legal risks associated with the provision of inaccurate information result in many franchisors refusing to weigh in on a franchisee’s anticipated profitability.
To date, five provinces, Alberta, Ontario, Prince Edward Island, New Brunswick and Manitoba, have enacted franchise legislation. If a franchised business is to be operated in one of these provinces, the franchisor must provide the prospective franchisee with a disclosure document which meets the requirements of the applicable legislation. Provincial franchise legislation specifically contemplates the provision of information which can be used to calculate a specific level or range of actual or potential sales, costs, income, revenue or profits (known as “earnings claims” in Alberta and “earnings projections” in the other regulated provinces) and imposes strict disclosure obligations on franchisors who choose to provide such information to prospective franchisees.
While there are nuanced differences between the various provinces’ treatment of earnings projections, the relevant disclosure obligations are similar in all five jurisdictions. First, if a franchisor provides earnings projections, the projections must be contained within the disclosure document. Secondly, earnings projections must be accompanied by statements specifying: (a) all underlying assumptions; (b) that the underlying assumptions are reasonable; (c) the period covered by the projection; (d) whether the projection is based on actual results of existing franchises and, if so, the locations, areas, territories or markets of such franchises; (e) if the projection is based on a business operated by the franchisor or a related party, that the information may differ in respect of a franchise operated by a franchisee; and (f) a location where substantiating information may be inspected. Failure to comply with these requirements constitutes a deficiency in disclosure and may entitle a franchisee to rescind (or cancel) the franchise agreement and pursue the franchisor for reimbursement of all amounts invested in the franchise.
The provision of earnings projections may also expose the franchisor to liability if subsequent events reveal that the franchisor’s information was inaccurate. In regulated provinces, if a franchisee suffers a loss as the result of a misrepresentation contained in the disclosure document, the franchisee has a statutory right of action for damages against the franchisor, the franchisor’s agent, the franchisor’s broker, the franchisor’s associate, and every person who signed the disclosure document. In unregulated provinces, a franchisee may be entitled to pursue the franchisor, among other persons, for common law damages arising from a misrepresentation.
A franchisor’s stance on earnings projections is typically driven by the maturity of the system, the number of franchises in operation, the financial performance of existing franchises, and the franchisor’s confidence in its ability to accurately project earnings. Some franchisors simply lack the experience and data necessary to prepare accurate projections, while others possess the necessary experience and data, but ultimately conclude that the risks associated with providing projections are too great.
Where a franchisor does not provide earnings projections, the disclosure document will typically contain a statement to that effect. If the franchised business is to be located in New Brunswick or Manitoba, such a statement is mandatory. Additionally, the franchisor may require that a prospective franchisee acknowledge, in writing, that it has not received and is not relying upon any earnings projections in deciding to acquire the franchise. If the franchisor has, in fact, provided information which is indicative of anticipated sales, costs, income, revenue or profits, a prospective franchisee should refuse to provide the requested acknowledgment.
The fact that a franchisor does not provide earnings projections does not mean that the prospective franchisee will lack the information it requires in order to make an informed investment decision. Existing franchisees are a valuable resource and are typically willing to provide prospective franchisees with general information regarding sales, operational expenses and profits. The franchisor’s disclosure document is also an important source of information. A prospective franchisee should undertake a careful review of the estimated costs of establishment, as well as the ongoing fees payable under the franchise agreement and related agreements, and should factor these amounts into its financial forecast. A prospective franchisee should also engage an accountant to assist in reviewing all pertinent financial information. By completing its own due diligence, a prospective franchisee will likely be able to prepare a more accurate and reliable estimate of future earnings than the franchisor’s standard projections can provide.