1. What financials are required for a franchisor operating in the United States?
The Federal Trade Commission requires audited financials for the franchisor for the last three fiscal years before the Franchise Disclosure Document issuance date. This means you need a balance sheet for the last two fiscal year-ends and a statement of operations, stockholders’ equity, and cash flows for the last three fiscal years. The audit has to be performed by an independent certified public accountant using U.S. GAAS. Also, the financial statements must be prepared in accordance with U.S. GAAP (complete with footnotes) and must compare at least two fiscal years.
Foreign franchisors selling franchises in the United States may comply by using International Financial Reporting Standards (IFRS), but these franchisors must reconcile their financial statements to U.S. GAAP and must audit the financials according to U.S. GAAP.
U.S. GAAP requires that a franchisor prepare financial statements on a consolidated basis where the franchisor owns a direct or beneficial controlling financial interest in a subsidiary.
2. Are financials required or allowed for any other entities besides the franchisor?
Parent Company: A franchisor must include the financials of a parent company if (1) the parent commits to perform post-sale obligations for the franchisor (e.g. training, site selection, etc.), or (2) if the parent guarantees obligations of the franchisor.
Sub-franchisor: A franchisor must include the financials of any sub-franchisor if the sub-franchisor is part of pre-sale activities and has post-sale obligations to franchisees.
Affiliate Company: A franchisor may substitute its own financials for those of an affiliate if the financials meet the standards in the first part above and the affiliate absolutely and unconditionally guarantees to assume the duties and obligations of the franchisor to the franchisee under the franchise agreement.
3. What financials are required for a start-up franchisor?
Most states allow start-up franchisors to phase-in the use of audit financials, as follows:
| Fiscal Year | Financial Statement Requirement |
|---|---|
| First year (part/full) | Unaudited opening balance sheet |
| Second year | Audited balance sheet as of the end of the first partial or full fiscal year |
| Third and subsequent years | All required financial statements for the previous fiscal year, plus any required statements from prior years |
Any unaudited financial statements must be prepared “in a form that conforms as closely as possible to audited statements,” which most states have interpreted to mean compliance with U.S. GAAP.
The phase-in may only be used by companies that are new to franchising and do not already have audited financials. It is not permitted for spin-offs, affiliates, or subsidiaries of an existing franchisor.
Unaudited statements are not accepted by Minnesota, New York, and Virginia, which means franchisors have to have the opening balance sheet audited. Also, California requires that any financial statements used in California must, at a minimum, be reviewed by an accountant. Maryland, North Dakota and Rhode Island permit phase-in by a start-up franchisor but will automatically impose a financial assurance condition (i.e., deferment or escrow of the franchise fee until the Franchisee opens for business).