Franchising is an excellent way for companies to expand their operations. Indeed, we have many clients that have pursued the franchising path with tremendous success.
However, some startup companies seek to establish a franchise in the first year of opening their business. While the enthusiasm is commendable, such prospective franchisors need to understand that the Federal Trade Commission (“FTC”) (which is the federal agency charged with governing franchises) requires that the franchisor disclose audited financial statements for the last three fiscal years before the issuance date of the Franchise Disclosure Document, which is the primary disclosure document that must be provided to prospective franchisees. In addition, the audit must be performed by an independent certified public accountant using U.S. generally accepted accounting principles.
While there is a phase-in period for start-up companies, which provides a three-year partial phase-in before full-blown audited financials are required, the burden of developing audited financial statements cannot be underestimated. By year three, the franchisor needs to be able to have fully audited financial statements of its operations. This is not only expensive, but it also requires strict accounting management of the operations of the company because even the unaudited financial statements during the phase-in period must be prepared in accordance with U.S. generally accepted accounting principles. Most startups will find it difficult to comply with this FTC legal requirement unless a significant investment is made.
Therefore, we generally advise startup companies to begin to consider franchising their business concept in year two or three, after the business is fairly established. While we do not want to quell the enthusiasm of clients, we certainly want to prepare clients for the realities of what the law requires. With proper planning, a successful franchise system can be developed.
If you have any questions regarding franchising your business or franchise law, please contact me, Santiago J. Padilla, Esq., at (305) 824-2400 or via email.