Financial Statement FAQs for New Franchisors

1.       What type of financial statements are required?

 Generally speaking, franchisors are required to provide audited financial statements for the last three fiscal years of the franchisor’s operations. These must be prepared by an independent auditor and should include a balance sheet, a statement of operations, stockholders’ equity, and cash flows for the last three fiscal years. The audit must be performed using Generally Accepted Accounting Standards, be prepared in accordance with U.S. GAAP (with footnotes) and should compare the last two fiscal years. We HIGHLY recommend going with an auditing firm that has some experience with franchisor financials.

 2.       I am new to franchising, what do I need to provide?

 For most states, there is a “phase-in” period of audited financial statements for franchisors in their first year of franchising. During the first fiscal year only, new franchisors may comply with the federal disclosure law, and many state franchise laws, by providing an unaudited opening balance sheet for the franchisor. The unaudited opening balance sheet must be prepared in a form that conforms as closely as possible to audited statements (in compliance with GAAP is the generally accepted standard).

 3.       Are there any states that require audited financials for new franchisors?

YES! If you intend to register to sell franchises in Minnesota, New York, or Virginia – you must provide audited financial statements even in your first year of franchising. In California, the financial statements for the franchisor entity must have a minimum of a “Review” by an accountant. In this context, “Review” is a term of art in the accounting world and is slightly below the level of scrutiny of a full audit.

 4.       What do you recommend we do when preparing our first set of financials?

 Because you will likely be creating a brand-new entity to act as the franchisor, there will be very little information to be audited for this new company. While you are permitted to use an unaudited opening balance sheet, we recommend going ahead and completing an audit of the new company’s opening balance sheet if possible. This way, if a franchise candidate pops up in the states that require audited financials, we can begin the registration process in these states right away. Obviously, if you know you intend to register in Minnesota, New York, Virginia, or California, then you will be preparing audited or “Reviewed” financial statements anyway.

 5.       Do I need to put a certain amount of money into the franchisor entity prior to preparing opening financial statements?

 The opening balance sheet of the franchisor entity is not required to reflect any certain amount of initial cash on hand, shareholders’ equity, etc. That said, many of the franchise registration states will look at the relative financial strength of the franchisor when deciding whether or not to impose financial impound requirements on your collection of initial franchise fees. If the registration state is not satisfied with the franchisor’s financial condition, they may require you to: (1) defer collection of any franchise fees until the franchisee opens for business; (2) put franchise fees into an escrow account established in that state (at your cost) until the franchisee opens for business; (3) require you to obtain and maintain a surety bond with licensed surety company authorized to do business in their state; (4) refuse to register the franchise offering in their state (rare).

 The impound requirements vary by state and are beyond the scope of this paper, but the general forms of impound are described above. We recommend that you put as much cash as reasonably possible onto the franchisor’s books prior to running the opening balance sheet. There is no bright line rule on when a state may require an impound of some sort, but generally any amount less than $100,000.00 on the franchisor’s opening balance sheet will likely trigger an impound in some, or all, of the states that impose them.

 6.       We do not have that type of cash available for the opening balance sheet, what do we do?

 That is OK! Remember, the initial cash infusion is designed to present the financial strength of the franchisor and to overcome the impound requirements that certain states impose. If you are not intending to register in any of the franchise registration states, this is not a problem. The registration states that most commonly issue impound requirements are: California, Hawaii, Illinois, Maryland, Minnesota, North Dakota, Virginia, and Washington.

 7.       I still need some assistance with what to do, who should I contact?

 You can reach out to one of the attorneys with Roda Chalfant to obtain further assistance with meeting your financial reporting obligations for your Franchise Disclosure Document. We are all on the same team and here to help you! Please contact us for specific questions or assistance.