The franchise rule set by the federal trade council states that a franchisor looking at selling or offering a franchise must provide a franchise disclosure document (FDD). The FDD contains a series of 23 items that cover different areas of the franchise business. Item 21 is one of the critical sections, and it holds Financials statement information about the Franchise. Generally, a franchisor is required to provide three years of audited financial statements in Item 21 FDD.
However, an exception to this rule is the franchisor phase-in process.
The phase-in process applies to new franchises operating in their first fiscal year. Since they have no audited financial statements, startup franchisors are permitted to phase in the financial statement.
How does the phase-in process work?
A start-up franchise operating in its first fiscal year is permitted to provide an unaudited first-year balance sheet in place of 3 years of audited financial statements.
Subsequently, the franchisor must provide relevant audited financial statements as they complete more fiscal years. The franchisor must provide an audited balance sheet at the end of its second fiscal year. Furthermore, the franchisor must provide audited financial statements for three subsequent years and other supporting documents at the end of the third fiscal year.
Requirements for Start-up Franchise Financial statement
Although the phase-in process exemption rule might seem simple, it comes with a few conditions.
- A franchise with a parent company operating as a spin-off, affiliate, or subsidiary with previous audited financial statements, cannot phase in its financial statement. They must provide the audited financial statements of the established Franchise.
- A franchise business that has operated as a company and audited financial statements before becoming a franchise is not covered by the phase-in exemption.
- The unaudited balance sheet must conform as closely as possible to the financial statement generally accepted accounting principles or other sec accounting standards.
Contact us to audit your franchise account to help you stay compliant, identify issues and boost your business profitability.
