When franchising your business, few sections of the Franchise Disclosure Document (FDD) are as powerful—or as scrutinized—as Item 19: Financial Performance Representations (FPRs). A well-constructed Item 19 can significantly improve franchise sales, build credibility with prospective franchisees, and position your brand as a scalable, profitable opportunity. A poorly prepared Item 19, however, can create legal exposure, undermine trust, and slow growth.
For emerging franchise brands, the key is not only presenting strong financial performance, but presenting it properly. This includes carefully analyzing your historical financials, structuring the right format for disclosure, and strategically reviewing add-backs to ensure that adjusted earnings accurately reflect the true profitability of the business model.
This article outlines:
- What Item 19 is and why it matters
- Legal and compliance considerations
- Different formats for presenting Item 19
- Understanding EBITDA and Seller’s Discretionary Earnings (SDE)
- Identifying and validating add-backs
- Common add-backs that strengthen your presentation
- Add-backs that create risk
- Building a defensible and compelling Item 19
- Best practices for maximizing value while maintaining compliance
Understanding Item 19: The Foundation of Financial Credibility
Item 19 is the only section of the FDD where a franchisor may legally provide financial performance information to prospective franchisees. If a franchisor chooses not to include an Item 19, they are prohibited from sharing earnings claims in any form—verbally or in writing.
An Item 19 can include:
- Gross revenue
- Average unit volume (AUV)
- Cost of goods sold
- Labor expenses
- Operating expenses
- EBITDA
- Net income
- Performance ranges (top third, median, bottom third)
- Company-owned location performance
- Franchisee performance (if applicable)
The purpose of Item 19 is not to “sell” inflated numbers—it is to provide a clear, factual, and substantiated representation of historical financial performance.
The stronger and more transparent your Item 19, the easier it becomes for candidates to secure financing, perform due diligence, and confidently move forward with your franchise system.
Dig deeper on how to build a Item 19: https://franchisefundingsolutions.com/understanding-add-backs-in-business-valuation-what-they-are-why-they-matter-and-how-to-apply-them-correctly/
Legal and Compliance Considerations
Before diving into strategy, it is critical to understand that Item 19 is a regulated disclosure governed by the FTC Franchise Rule and state franchise laws.
Key requirements include:
- All financial representations must be based on historical data.
- The franchisor must have written substantiation for every claim.
- The disclosure must clearly explain assumptions and limitations.
- The methodology must be transparent.
- If projections are included, they must be reasonable and supported.
This is not a marketing document—it is a compliance document. Every number must be defensible.
Choosing the Right Item 19 Structure
There are several common formats for Item 19 disclosures:
1. Company-Owned Location Performance
For emerging franchisors, this is often the most straightforward approach. You present performance data from corporate-owned locations.
Advantages:
- Full access to financial records
- Easier substantiation
- Greater control over data accuracy
2. Franchisee Performance
For established systems, this includes financial performance from franchised units.
This can be:
- Average performance
- Median performance
- Performance by quartile or percentile
- Performance by geography
- Performance by tenure
3. Subset Reporting
You may choose to report:
- Mature units only (e.g., open 12+ months)
- Units open full calendar year
- Units in specific markets
- Units meeting certain operational criteria
The structure you choose should reflect consistency, fairness, and defensibility.
EBITDA vs. SDE: Understanding Profit Metrics
When presenting profitability in Item 19, most franchisors rely on either:
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)
This metric reflects operational profitability before financing and tax structure.
It is ideal for:
- Multi-unit operators
- Institutional investors
- Scalable business models
Seller’s Discretionary Earnings (SDE)
SDE includes:
- Net income
- Plus owner salary
- Plus discretionary expenses
- Plus certain non-recurring costs
SDE is commonly used in small business sales and works well when presenting owner-operator models.
Choosing between EBITDA and SDE depends on your franchise target audience.
The Role of Add-Backs in Item 19
Add-backs are adjustments made to reported net income to reflect the true earning power of the business. They remove expenses that are:
- Non-recurring
- Owner-specific
- Discretionary
- Non-operational
- One-time events
When properly structured, add-backs help normalize earnings and present the business as it would operate under a standardized franchise model.
The goal is not to inflate numbers—but to clarify them.
Common Add-Back Categories
1. Owner Compensation
If the owner is overpaying themselves or underpaying themselves relative to market standards, adjustments may be necessary.
For example:
- Owner takes $250,000 salary in a business that requires a $90,000 general manager.
- The excess $160,000 may be added back when calculating EBITDA for franchise presentation.
Or:
- Owner takes no salary.
- A reasonable management salary should be inserted as an expense for modeling purposes.
Transparency is key.
2. Personal Expenses Run Through the Business
Many small businesses run discretionary expenses through operations, such as:
- Personal vehicles
- Family travel
- Meals unrelated to operations
- Home office expenses
- Personal insurance
These expenses can be added back if properly documented and clearly non-operational.
3. Non-Recurring Legal or Professional Fees
Examples:
- One-time lawsuit settlements
- Franchise formation legal fees
- Brand development consulting
- Major rebranding costs
If these are non-recurring, they may be appropriate add-backs.
4. Start-Up or Ramp-Up Costs
If your corporate location incurred abnormal expenses during opening or stabilization periods, these may not reflect ongoing operational performance.
Examples:
- Grand opening marketing spikes
- Construction delays
- Initial training inefficiencies
However, caution must be exercised—these cannot mislead prospective franchisees.
5. Above-Market Rent (Related Party Transactions)
If the property is owned by a related entity charging above-market rent, you may normalize the expense to market rate.
You must disclose related-party arrangements clearly.
6. Excess Staffing
If corporate locations carry redundant staff not required in franchise model operations, adjustments may be reasonable.
For example:
- Corporate HR staff allocated to one location
- Training personnel not required at unit level
Add-Backs That Create Risk
Not all adjustments are appropriate. Aggressive or unsupported add-backs can create regulatory and legal exposure.
Avoid:
- Hypothetical efficiencies not yet achieved
- “Projected” cost savings
- Future supplier discounts not in place
- Speculative revenue increases
- Removing legitimate ongoing expenses
If it happens every year, it’s probably not non-recurring.
If every location incurs the expense, it likely belongs in the model.
Maximizing Profitability the Right Way
The objective is to present a clear picture of what a properly operated franchise unit can earn—not to create artificially inflated performance.
To maximize profitability presentation:
Step 1: Clean Up Financial Records
Before preparing Item 19:
- Separate personal and business expenses
- Normalize payroll structure
- Review vendor contracts
- Analyze cost of goods sold
- Audit rent and occupancy costs
Professional bookkeeping is critical.
Step 2: Standardize the Franchise Model
Your corporate unit may not operate exactly like your franchise model will.
Adjust for:
- Right-sized staffing
- Standardized marketing contributions
- Royalty structures
- Technology platform fees
- Supply chain pricing
The goal is to present the economics of the replicable model—not a one-off corporate operation.
Step 3: Work with Professionals
Item 19 preparation should involve:
- Franchise attorney
- Franchise consultant
- CPA with franchise experience
Financial representations must align with legal compliance.
Step 4: Use Data Subsets Strategically
If your brand has high-performing mature locations, you may structure disclosure around:
- Units open 24+ months
- Units in stabilized markets
- Owner-operated vs absentee
This helps present performance clarity without misleading averages diluted by new locations.
Building a Compelling Yet Defensible Narrative
A strong Item 19 includes:
- Clear description of reporting period
- Number of units included
- Definitions of revenue and expense categories
- Disclosure of excluded units
- Explanation of add-backs
- Assumptions used
Clarity builds trust.
Prospective franchisees—and their advisors—will dissect these numbers. Transparency builds credibility.
Supporting Franchise Sales with Strong Economics
A properly structured Item 19:
- Improves validation calls
- Helps franchisees obtain SBA financing
- Shortens sales cycles
- Increases close rates
- Attracts higher-quality candidates
Banks and lenders rely heavily on documented financial performance. A clean, well-supported EBITDA presentation with reasonable add-backs strengthens lending confidence.
Ethical Considerations and Long-Term Brand Value
Overstated financial representations may help sell a few units quickly—but they damage brand reputation and increase litigation risk.
Long-term franchise growth depends on:
- Realistic expectations
- Strong unit-level economics
- Consistent operational performance
- Transparent communication
An honest Item 19 may show slightly lower profitability than an aggressively adjusted one—but it builds sustainable growth.
Practical Example of Add-Back Strategy
Imagine a corporate location showing:
- Revenue: $1,200,000
- Net Income: $80,000
Upon review:
- Owner salary: $220,000 (market GM salary: $100,000)
- Personal vehicle: $18,000
- One-time legal expense: $35,000
- Excess marketing launch spend: $40,000
Adjusted EBITDA calculation:
Net Income: $80,000
Add back excess owner salary: $120,000
Add back vehicle: $18,000
Add back legal: $35,000
Add back excess marketing: $40,000
Adjusted EBITDA: $293,000
Now the earnings reflect operational performance more accurately.
The key: every adjustment must be documented and disclosed.
Turning Financial Performance into Franchise Growth
Creating a strong Item 19 is both an analytical and strategic exercise. It requires deep understanding of your financial statements, disciplined evaluation of add-backs, and careful legal structuring.
When done correctly, Item 19 becomes one of your most powerful franchise development tools.
It demonstrates:
- Profitability
- Replicability
- Financial discipline
- Brand maturity
- Scalability
By thoroughly reviewing add-backs, cleaning up financials, normalizing expenses, and presenting defensible EBITDA, you maximize profitability presentation while maintaining compliance and credibility.
Franchising is not about selling dreams—it is about replicating proven systems.
A well-constructed Item 19 proves that your system works.
And when your financial story is clear, transparent, and professionally presented, it becomes one of the strongest foundations for sustainable franchise growth.
For more information on how to put together a Item 19 and how to Franchise Your Business, contact Franchise Marketing Systems: www.FMSFranchise.com
Franchise Marketing Systems 