Best Practices for Franchisor Cooperative Advertising Funds

If you are a franchisor with a cooperative advertising fund, now is a good time to evaluate how your ad fund is set up and determine whether or not a better option exists.
 
Marketing and advertising for a concept is funded through contributions by franchised and corporate-owned stores. The bankroll is comprised mainly of ad fees, typically a pre-determined percentage of weekly or monthly restaurant sales. As the franchisor, you are responsible for the administration of the ad funds. It is important to ensure all interested parties, particularly your franchisees, understand what the money is used for, where it is kept, and what reporting requirements exist.
 
Remember to keep the accounting simple and remain transparent to reduce the risk of litigation. Some best practices for maintaining an ad fund include:

• Set up a separate business entity to track all incoming and outgoing activity. We suggest a C corporation (it eliminates the need for K-1s) or an LLC acting as a C corporation.

• Maintain a separate bank account for ad funds contributed by corporate-owned and franchised stores. All contributions and disbursements should flow in and out of this, helping to maintain a good paper trail.

• Be specific on how the ad fund will be funded. Some franchisors may include vendor and supplier rebates or coupon distribution revenue (e.g., Groupon).

• Ensure the Franchise Disclosure Document and franchise agreement describe the funds’ intended use and the types of expenses to be included. We commonly see overhead and administrative expenses, so make certain the documentation states this.

• If the ad fund is part of the franchisor entity, maintain a separate general ledger account sequence for all receipts and disbursements. Detailed account descriptions will help in overall reporting to your franchisees when demonstrating how the funds were spent.

 
In practice, most franchisors are accounting for the advertising fund on the balance sheet currently; however, this will most likely need to change under the new revenue recognition standard. We will have an upcoming blog discussing the changes to advertising funds under the new revenue recognition standard.
 
When the franchisor spends what is allocated, the year-end liability is low; however, some franchisors like to keep a cushion. Funds may be saved in case of an incident (e.g., food poisoning, credit card skimming) that may damage the concept’s reputation and require emergency marketing to counteract negative publicity. If you have collected more money than you paid out at year’s end, an advertising fund liability would exist on the balance sheet. Should the reverse happen, an asset would exist that would need to be evaluated for overall recoverability in future periods.  Under the balance sheet approach commonly used, there is no impact from the ad fund on the profit and loss (P&L) statement.
 

Tax Considerations

For tax purposes, there are differing methods of reporting income and expense for ad funds with separate entities and ones maintained within the franchisor entity. For funds that are maintained separately, there should be no income gain or loss recognized from the ad fund on the tax return. For funds that are maintained internally with the franchisor, the advertising fee income is considered taxable and disbursements are considered deductible expenses. This may result in taxable income or a loss for the company in a particular year. However, the fund will ultimately come to the same point assuming the disbursements equal the contributions.
 
Take great care when administering a cooperative advertising fund – your relationships with current and future franchisees may depend on it. By following best practices and remaining diligent, you can avoid litigation and other unnecessary risks.

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