COVID restrictions changed many business models in 2020. How did your franchise system change during 2020? Consider the conversation that your salespeople will want to have with prospective franchisees this year about how your system adapted to the restrictions that resulted from the pandemic. Not addressing those changes in your Franchise Disclosure Document ("FDD") could prevent those conversations from taking place and deter a would-be buyer from becoming your next franchisee.
Many businesses changed their physical design or layout, added outdoor dining areas or redesigned indoor spaces, changed menus to accommodate delivery services and take-out, offered curbside pick-up or additional drive-thru lanes, added plexiglass dividers, and other safety measures to accommodate social distancing rules. Some systems are incorporating these changes into permanent features.
Consumer demand changed during 2020 as well, and some of those changes could be permanent. Depending on what changes you expect to see this year and beyond, this could require changes to the disclosures in your FDD related to the description of the goods and services offered, initial investment costs, and others.
Training and support of franchisees may be an area where changes made during 2020 will become standard in the future. Many franchisors started holding group calls and video conferences with franchisees to discuss coping with government restrictions, loan applications, negotiating changes to leases, new sanitation measures, and other things that business owners were facing. In some systems, those group calls have become a regular feature of franchisees' support as they navigate the lifting of restrictions on the retail sector. Be sure to add new methods of support to your FDD disclosures.
Updating Financial Performance Representations
Financial performance representations ("FPR") made in 2021 using sales data for 2020 may show significantly less revenue than in 2019 due to COVID restrictions. In addition, some franchised businesses closed temporarily in 2020 but may be planning to re-open in 2021. Franchisors should keep in mind that they are required to disclose "material" changes in the franchise system as they occur, including a material decrease in the number of outlets. Many franchisors will be disclosing FPR data from 2019 side-by-side with 2020 data to enable salespeople to talk about the results of a 'normal' year as compared to 2020. All disclosures in Item 19 require a "reasonable basis," and you must have written substantiation for the data presented. Some franchisors may want to present data by state or by region, given that some areas of the country were more restricted than others. If this makes sense for your system, a supplemental FPR for prospects looking to develop a business in a particular state or region might be the most effective way to disclose that information.
Practical Expedient Makes Recognition of Initial Franchise Fees Easier
In January 2021, the Financial Accounting Standards Board issued a "practical expedient" whereby a privately-held franchisor can consolidate six of its pre-opening obligations into a single performance obligation when it applies FASB 606 to recognize revenue from the initial franchise fee. The six pre-opening services are:
- site selection assistance;
- assistance in obtaining facilities and preparing the facilities for their intended use, including related financing, architectural, engineering services, and lease negotiation;
- preparing and distributing operations manuals;
- bookkeeping, information technology, and advisory services, including setting up the franchisee's records and advising the franchisee about income, real estate, and other taxes or regulations affecting the franchisee's business; and
- inspection, testing, and other quality control programs.
While this practical expedient will allow franchisors to recognize revenue related to these services when they are performed, thus simplifying Step 2 of the process in determining how much revenue can be recognized, it does not impact Step 4, which requires franchisors to determine the value of those services to conclude how much revenue can be recognized. Franchisors cannot assume that the value of the preopening services equals the amount of the initial franchise fee.
To learn more, watch the recap video of our most recent Women’s Franchise Network event. If you have further questions regarding your FDD’s or FPR's, please contact Lynne Hanson, co-chair of the Franchise and Distribution Group. If you have questions regarding your audited financial statements, please contact Angela Newell, National Assurance Partner at BDO USA, LLP.
A version of this article was published in QSR Magazine and Franchise Update.