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What kind of financial statements do I need for my FDD?

The FDD Guidelines require franchisors to include certain financial statements in their FDDs. Generally, these financial statements must be audited by an independent certified public accountant. In some situations however, unaudited financial statements may be required or permitted.

Audited Financial Statements

Under the FDD Guidelines, a franchisor must include the following financial statements, prepared in accordance with United States generally accepted accounting principles (“GAAP”) (as revised by any future government mandated accounting principles, or as permitted by the Securities and Exchange Commission), in its disclosure document:

  1. 1. a balance sheet as of the end of the 2 most recent fiscal years;
  2.  2. a statement of operations for the 3 most recent fiscal years;
  3.  3. a statement of stockholders’ equity for the 3 most recent fiscal years; and
  4.  4. a statement of cash flows for the 3 most recent fiscal years.

These financial statements must be audited by an independent certified public accountant and must be presented in a comparative format including at least 2 years.

Affiliate Audited Financial Statements

If the franchisor does not have audited financial statements (usually because its financial results are included with the audited results of an affiliated company), the franchisor may include the affiliated entity’s audited financial statements (as described above). In addition, the affiliated entity must absolutely and unconditionally guarantee to assume the duties and obligations of the franchisor under the franchise agreement. A copy of the affiliate’s guarantee must be included in the FDD. This guarantee applies only to the franchisor’s obligations to franchisees and not any obligations to third parties.

Franchisor’s Subsidiaries

If the franchisor owns a direct or indirect controlling financial interest in a subsidiary, the franchisor’s financial statements must include the results of the franchisor and the subsidiary.

Start-Up Franchisor Phase-In

A start-up franchise system that does not yet have the required audited financial statements may phase-in the use of audited financial statements by providing at least the following:

  1. 1. For the franchisor’s first partial or full fiscal year selling franchises – an   unaudited opening balance sheet.
  2.  2. For the franchisor’s second fiscal year selling franchises – an audited   balance sheet as of the end of the first partial or full fiscal year selling        franchises.
  3.  3. For the franchisor’s third and all later fiscal years selling franchises – audited financial statements for the previous fiscal year in accordance with the first paragraph of this article, plus the previously disclosed financial statements from 1 and 2, immediately above, that are still necessary to provide 2 years of audited balance sheets and 3 years of the other statements.

The unaudited opening balance sheet should be prepared in a format that conforms as closely as possible to audited statements.

Note that the phase-in is not available to spin-offs, affiliates, or subsidiaries of existing franchisors that have prepared audited financial statements in the past. Therefore, a franchisor cannot avoid the requirement for audited financial statements by forming a new company to be the franchisor.

Subfranchisors

If a subfranchisor also will be selling franchises, the franchisor’s audited financial statements and the subfranchisor’s audited financial statements must both be presented.

State Review of Financial Statements

When your audited financial statements are submitted to each state as part of your registration, a state examiner will conduct a substantive review of the financial statements, to determine whether the examiner should impose a financial restriction such as an escrow condition, deferral of initial fees, surety bond, etc. Several financial statement characteristics will automatically trigger a financial restriction in some states. These characteristics include a net operating loss, negative equity or a current ratio (current assets divided by current liabilities) of less than 1 to 1. To the extent possible, you should plan ahead to avoid these characteristics, i.e., avoid draining cash from the franchisor immediately before the fiscal year end to the extent that the current ratio will fall below 1 to 1 or pay sufficient current liabilities before fiscal year end. In Virginia, you will not be permitted to register your franchise offering if your balance sheet demonstrates a negative equity.

Unaudited Financial Statements

In some states, if the application for registration in that state is filed more than 90 days after the date of the most recent audited balance sheet, the franchisor also must submit unaudited financial statements, including a balance sheet and statement of operations, that are current within 90 days of the application date.

     

Franchise Your Business

                                    

  800.343.3213