If you want to start a franchise, familiarizing yourself with the FTC rule is essential. The Federal Trade Commission (FTC) requires franchisors to provide financial statements as part of the item 21 Franchise disclosure document at least 14 days before a franchisee signs any agreement. Failure to provide the proper documents attracts strict sanctions as it’s a direct violation of federal laws.
Financial Statement Requirements for Franchise
Depending on your current fiscal year, a franchise falls under two categories with different financial statement requirements for item 21 FDD.
Financial Statement Requirements for Start-up Franchise
Startup franchises are franchises operating within their first fiscal year. Although the FTC rule mandates all franchises to provide audited financial statements, startup franchises are exempt from this rule. Instead, they enjoy a phase in exception rule that allows provision of unaudited, initial opening franchise balance sheet and account consent document.
The phase-in rule only applies to start-up franchises that aren’t a spin-off, affiliates, subsidiaries, or entities related to an established franchise. Also, all documents must comply with the Generally accepted accounting principles (GAAP) of the United States of America.
Audited Financial statement requirements for Established Franchise
In the context of the FTC rule, an established franchise is a franchise operating in its second fiscal year and above.
Unlike a start-up franchise, an established franchise operating in its second year must provide an audited balance sheet that complies with the USA’s generally accepted auditing standards (GAAS).
However, established franchises operating in their third fiscal year and above must provide the following documents:
- Three years of an audited balance sheet for FY1 & FY2 ending
- A statement of operations for the three most recent fiscal year
- A statement of stockholders’ equity in the company and cash flows.
Note: Asides from the general financial statement requirements, there are state-specific requirements too. It’s essential to check for your state requirements and comply accordingly.
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