In terms of the requirements for the offering circular in California, do I need to have audited financials for my business before I franchise?
As a franchise attorney , helping companies franchise a business concept and advising individuals, as a franchise expert, on making franchise investments, as well as a former owner of a very successful franchise, I can say the following.
It depends on how you set things up - as always, the Devil is in the details. There is a way for you to avoid audited financials and still comply with California (and federal) franchise laws. This is not an area you want to try on your own or use your "business attorney" to deal with. Besides the financials, there are numerous other areas and issues to consider where the do-it-right approach will not only save significant money, but also result is a much better franchise program. Of course, this requires the experience of a knowledgeable franchise attorney familiar with the legal, financial and business aspects of franchising.
Good luck !
Kevin B. Murphy, B.S., M.B.A., J.D.
Franchise Attorney & Franchise Expert
Director of Operations - Mr. Franchise
FRANCHISE FOUNDATIONS APC
YOU DO NOT NEED AUDITED STATEMENTS FOR YOUR FIRST YEAR FRANCHISING IN CALIFORNIA AS PROVIDED BELOW. I have CA CPA contacts that can do this for new CA franchisors, if you want to contact me off line. I would be glad to give you a free consultation of what else you would need to do to start franchising your business in CA. firstname.lastname@example.org
(2) A start-up franchise system that does not yet have audited financial statements
may phase-in the use of audited financial statements by providing, at a minimum, the following
statements at the indicated times:
(i) The franchisor’s first partial or full fiscal year selling franchises: NEED An unaudited opening balance sheet.
(ii) The franchisor’s second fiscal year selling franchises: NEED Audited balance sheet opinion as of the end of the first partial or full fiscal year selling franchises.
(iii) The franchisor’s third and subsequent fiscal years selling franchises: NEED
All required financial statements for the previous fiscal year, plus any previously disclosed audited statements that still must be disclosed according to paragraphs (1)(i) and (ii) of this Item 21.
(iv) Start-up franchisors may phase-in the disclosure of audited financial statements, provided the franchisor:
(A) Prepares audited financial statements as soon as practicable.
(B) Prepares unaudited statements in a format that conforms as closely as possible to audited statements.
(C) Includes one or more years of unaudited financial statements or clearly and
conspicuously discloses in this section that the franchisor has not been in business for three years
or more, and cannot include all financial statements required in paragraphs (1)(i) and (ii) of this
The FTC Franchise Rule and the California Franchise Investment Law both require a franchisor to provide audited financials for the prior three years as part of the franchisor's Franchise Disclosure Document. The Franchise Rule does provide, however, that a "start-up franchisor" that does not yet have audited financial statements can phase-in the use of the audited statements over a three-year period. Under the Rule, the franchisor can provide an unaudited opening balance sheet during the franchisor's first partial or full fiscal year selling franchises.
Having said that, some of the franchise registration states WILL NOT accept unaudited financial statements from a start-up franchisor. California is usually one of those states; most of the California examiners (at least in my experience) will not accept anunaudited opening balance sheet, even from a start-up franchisor, and will instead require the balance sheet to be audited if you plan to register there.
One of the things you should also consider is creating a separate legal entity for your franchising company. This is advisable for a number of reasons, and it has the additional benefit of making your initial audit easier for the CPA. You really should discuss these issues with legal counsel experienced in franchise law.
California allows the use of "reviewed" financial statements for a newly-formed franchisor entity for the first FDD. While reviewed financial statements still require the use of an independent CPA, the level of oversight by the CPA is much less than for audited financial statements.
If you may be offering franchises in Maryland, Minnesota, New York or Virginia, then you might as well get audited statements from the start, as these states require audited statements for all franchisors.
Federal law and CA law will govern the requirements of the disclosure document. In either case you must have audited financial statements if the company that is franchising has been in business for more than a year or two. If your franchise company is new (created to franchise the business), then you can have merely an unaudited opening balance sheet the initial year.
With that said, you should have the guidance and expertise of an experienced franchise attorney to advise you and to prepare the documents. Franchise law is quite complex and not something that you, or an inexperienced attorney, should attempt to handle.
Please feel free to call me (215-525-1165 x101) if you have further questions.
If your business is new to franchising then you may not need audited financial statements. However my recommendation is that at a minimum you start off with an audited opening balance sheet. However the requirements vary and require an assessment as to the prior business history of your franchise company. The following article provides an additional summary, however ultimately you do need to review this issue with a franchise lawyer.
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