Key Franchisor Requirements: The FDD and Audited Financial Statements

If your company plans to become a franchisor, it is important to review all franchise rules and regulations governed by the Federal Trade Commission (FTC). One of the most important requirements is that, as a franchisor, you will have to provide prospective franchisees a Franchise Disclosure Document (FDD) at least 14 days before you sign any agreements or accept any payments from them.
 
The FDD contains various details about your franchising business, its financial performance, and other key information that provides a prospective franchisee enough data to make an educated decision of whether to invest in your franchise or not.
 
A specific item required in all FDDs is a set of audited financial statements. These financial statements must be prepared in accordance with United States generally accepted accounting principles (US GAAP) for all domestic companies. Certain foreign companies have some flexibility in preparation but require a reconciliation to US GAAP. The audit of the financial statements must be conducted in accordance with generally accepted auditing standards in the United States, without exception.
 
In general, three years of audited financial statements are required. However, in line with the FTC Franchise Rule, it should be noted that there are additional FDD financial statement requirements, as well as other options surrounding the necessary financial statements in the following situations:

• Parent Financial Information:

  • As franchisor, you must also disclose the financial statements of any parent corporation in two circumstances:

    • When the parent commits to perform post-sale obligations for the franchisor; or

    • When the parent guarantees obligations of the franchisor (a copy of the guarantee is required to be included in the FDD).

• Affiliate Financial Information:

  • Under certain specific Franchise Rule circumstances, as franchisor you are permitted to substitute the financial statements of an affiliate for your own financial statements if the affiliate “absolutely and unconditionally” guarantees to assume the duties and obligations of the franchisor to the franchisee under the franchise agreement (a copy of the guarantee is required to be included in the FDD).

• Subfranchisor Financial Information:

  • A franchisor is required to disclose the information of any subfranchisor; however, this is limited to circumstances only when the subfranchisor steps into the shoes of the franchisor by engaging in both pre-sale activities and performing post-sale obligations.

• Phase-In of Audited Financial Statements:

  • For companies that are new to franchising and have not yet had audited financial statements, certain states allow for a phase-in of audited financial statements over the course of three years (it is important to note that several states do not allow for this and specific research on this matter should be performed prior to implementation). Here is how the phase-in works:

    • An unaudited opening balance sheet is required for fiscal year one.

    • An audited balance sheet opinion over year one and year two is required for fiscal year two.

    • All required financial statements are required starting in fiscal year three and beyond.

  • If you have not been in business as a franchisor for three or more years, you should disclose this clearly within the FDD.

 
A franchisor’s FDD is not required to be federally registered but several states will require you to either register (with varying strict regulations and requirements) or file (with more flexible requirements) your FDDs with certain state bureaus or agencies within a certain time period from the end of their fiscal years.
 
Additional state requirements surrounding the FDD, and the financial statements included in the FDD, can vary, so if you’re looking to start franchising, you should investigate what the compliance requirements are in the states where you operate.
 
You should refer to the FTC Franchise Rule Compliance Guide to ensure your company remains in compliance with regards to the FDD and its filing. This guide provides direction on complying with FTC Franchise Rule, full details on franchisor requirements, and full examples of an FDD’s exhibits and disclosures.
 
To keep up with the latest thoughts from BDO’s Restaurant practice, please subscribe to the Selections Blog on the Selections homepage here, and following us on Twitter at @BDORestaurant.