“Substantial Change”, “Reasonable Basis” and “Historically Correct” are terms that Franchisors are or should be very familiar with, particularly when preparing Franchise 2021 Disclosure documents and considering the inclusion of financial performance statements in Item 19 pull.
Some of these considerations for item 19 are covered here and further elucidated in hypothetical scenarios discussed by Dale Cantone, Maryland’s assistant attorney general and assistant securities commissioner, with attorneys Dawn Johnson and Cheryl Mullin. The three were part of a panel during the International Franchise Associations Legal Symposium earlier this month.
Using a few real-world examples, Cantone described the hypothetical situation of Josephine’s 150 unit pizza, a delivery-focused, limited seating concept that was uniquely positioned to perform well during the COVID-19 pandemic. However, as business restrictions eased, sales slowed and Josephine wrote a memo to her management team calling the 2020 sales a “coincidence” and predicting future sales will be similar to 2019. Can the franchisor include its strong sales for 2020 in item 19? Asked Cantone.
More information is always better for potential franchisees, said Mullin of law firm Mullin Rybicki, who noted that they would be looking for a way to put the 2020 data into context. “I would advise the customer if you can put 2019 numbers, 2020 numbers, and 2021 numbers, include all the information you have,” she said, being careful not to rely on any disclaimer, Instead, add a footnote about changing consumer behavior and increasing takeaway sales.
“I think this is really good information to be shared in a footnote, or something that historically is the journey that we have been on and that we are here, and that is all we know,” said Mullin .
Cantone, who noted that in similar situations, some franchisors choose not to include FPRs this year because they don’t believe their company will repeat 2020 performance, others only include 2019 and earlier years but omit dates for 2020 . These franchisors should expect questions from government auditors and include a cover letter explaining why the 2020 numbers were omitted.
“I would imagine that most state regulators would agree that this is still an option for an FPR and still has a reasonable foundation. And it is sensible not to give any numbers that the franchisor believes are not representative and in this case a coincidence, ”he said.
He noted that regulators are “on guard” about the language of the disclaimer, and franchisors cannot simply include a range of financial performance data, but can say why franchisees cannot expect to see those results in the future.
PPP Loans As Revenue?
In the second scenario of the fictional Specialty Learning Annex franchise, the educational concept’s revenues were heavily impacted by the pandemic, but the company received a $ 65,000 Paycheck Protection Program loan that it expects not to have to be repaid. Now the franchisor plans, Cantone said, to count the PPP money as total gross sales and include it in item 19. “Is that a good idea?” He asked.
“I think it’s a terrible idea,” said Mullin, as state regulators want an explanation of what’s included in gross revenue, and “PPP money or any type of outsourced revenue is clearly not sales.”
“There is no way I would include PPP revenue as sales,” she said.
However, Cantone noted that an explanation of the PPP loan money might be appropriate to explain this in a footnote. “As a regulator, I don’t mind,” he said, because if the PPP money supports the business in 2020, that’s a good thing for a prospect. He added that franchisors view PPP money as revenue and that regulators have no way of knowing.