If you are looking to franchise your restaurant brand or are relatively new to franchising, it is important to understand your requirements for providing financial information within your Franchise Disclosure Document (FDD). The first requirement relates to financial information of your franchising entity. Item 21 in the FDD requires you to provide copies of your audited financial statements for the most recent three fiscal years. For domestic entities, these financial statements must be presented in accordance with U.S. generally accepted accounting principals (GAAP). They must reflect the financial condition of any subsidiaries that you have a direct or beneficial controlling financial interest in.
A phase-in of audited financial statements is allowed for franchisors that are new to franchising and do not yet have audited financial statements. The phase-in allows a new franchisor to provide only an unaudited opening balance sheet with its first franchise disclosure document filing, and this balance sheet must be prepared in accordance with GAAP. However, individual state requirements may be different, so it is best to discuss with your franchise attorney to determine the requirements in those states you expect to file in. If you already have audited financial statements before commencing franchising activities, you may not use the phase-in. Furthermore, if you are already franchising and have provided audited financial statements in the past you can not create a spin-off, affiliate or subsidiary in order to avoid the audit requirement
The next set of provided information in your FDD relates to financial performance representations. Prospective franchisees will likely want to know certain information related to how their franchise location is expected to perform. Item 19 in the FDD provides an avenue for you to provide certain information that you choose. There is no requirement for what information needs to be included in this section of the FDD. Examples of information that can be included are net sales, earnings before interest, taxes, depreciation and amortization (EBITDA), or cost breakdown for goods, labor, leases, etc. This information can either provide historical or projected information, which must be based on both the performance of franchisor-owned locations as well as existing franchised locations. Furthermore, you must have a reasonable basis and written substantiations for the representations and disclose the bases and assumptions underlying the representations.
Providing these financial performance representations is helpful to showcase your restaurant brand and can be very helpful in securing the franchise sales. As all prospective franchisees need to be on a level playing field, you are limited to providing these representations through the FDD and are not allowed to provide any further representations outside of what is disclosed in the FDD, so care will need to be given when determining what information to include here. You may elect to not include this information; especially, if you are relatively new to franchising. If you elect to not include this information, you are required to have specific language in place of this and cannot include any other information within this section. The requirements governing the Item 19 disclosures are vast so it is helpful to review the U.S. Federal Trade Commission Franchise Rule Compliance Guide for detailed guidance, which can be found here: US FTC Compliance Guide or consult with your franchise attorney.
For more on the financial statements required from franchisors, including franchise disclosure documents, check out this article.
If you have any questions on the above, or about restaurant franchising in general, feel free to contact a Henry+Horne professional, who is eager to assist you.
Jonathan Poppel, CPA