If you’ve considered franchising your business, there are a number of legal and accounting-related matters you should be aware of and consider. Franchise regulations in the United States are governed by the Federal Trade Commission (FTC); however, each state has its own set of rules for franchising in their state – some of which are more detailed and stricter than others. States fall into one of three categories:
- Registration State
- Filing State
- Non-Registration State
These categories are based on whether the state requires filings, fees, and other regulations to guide its franchising requirements. We recommend you consult with a franchise lawyer to ensure you are meeting all required federal and state rules and regulations.
The FTC requires each franchisor to prepare a Franchise Disclosure Document (FDD), which is required to be made available to a prospective franchisee at least 14 days prior to any agreements being signed or payment being accepted. The FDD requires extensive information about the concept and franchisor entity, including that the FDD must include three years (note that there are exceptions to this rule, see below) of audited financial statements that are in compliance with United States Generally Accepted Accounting Principles (US GAAP).
Often times we see entities created for the sole purpose of franchising. These entities may be newly created, going through the FDD process for the first time, and not have three years of information to be audited. The rules allow for phasing in this U.S. GAAP audit requirement over the course of three years.
- Initial year
- The Company would include an unaudited opening balance sheet in compliance with US GAAP.
- It is noted that this initial year will be required to be audited for inclusion in the year two FDD, as noted below. Often items we do see audits performed over this initial year so that information is comparable between the initial year and year two, and for assurance that the financial statements are presented in accordance with US GAAP.
- Year two
- The Company would include audited financial statements in accordance with US GAAP over years one and two.
- Year three and thereafter
- The Company would include three years of audited financial statements in accordance with US GAAP.
There are no requirements to file your FDD on a federal level, but as outlined above certain states have varying degrees of requirements. Some of these requirements may also have timelines associated with them, which, if required, are commonly seen as 90 or 120 days after the Company’s fiscal year-end. We recommend that you are aware of these requirements timelines so you can schedule your audit fieldwork and related deliverables accordingly in order to prevent potential disruption to your ability to sell franchises.
In future issues of GBQ’s Table Talk newsletter, we will dive into other FDD requirements and franchisor matters, such as franchisor-specific accounting, additional financial considerations, challenges for franchisors, and more. Be among the first to receive industry news and advice delivered straight to your inbox by subscribing today.
If you have questions on any of the topics listed above, please contact Kari Maue or your GBQ advisor.
Article written by:
Kari Maue, CPA
Director, Assurance & Business Advisory Services
