One of the biggest frustration points for new franchisors is the sticker shock in terms of dollars, time and headache when they learn that they need audited financial statements of their franchisor entity.
Franchisors are required to include financial statements in their FDD, that are audited in accordance with generally accepted accounting principals (GAAP). Audited financial statements are much more than just confirming your bank statements against your QuickBooks. The purpose of these statements is to provide an assurance to any reader of the statements that the company’s management has presented a true and fair view of the company’s financial performance and position.
Typically, audited financials are used for larger, more complex companies such as public companies or companies that have raised millions of dollars. In order for investors and lenders to have a clear picture of the financial condition of the company, audited financial statements are prepared by a licensed certified public accountant, or CPA, who was not involved in the day-to-day transactions and who will “judge” the information and the source of the information and produce a formal report that allows outsiders to make more informed decisions. Government regulations, in an effort to bring transparency to prospective franchisees’ evaluation of a franchisor, require these statements to be prepared by an independent third party to give prospects that same level of comfort.
Recognizing the cost and complexity in putting together audited financial statements, the federal government allows a phase in over time. This can, however, be a double-edged sword. The auditors will not just be looking at information on its face, but will be diving deeper into how money is processed through the company, who has control of paying bills and authorizing expenditures and what measures, processes and systems are in place to ensure accuracy and double checks. If a franchisor ignores these processes and systems in their first year or two in operation because they don’t need audited financials, when they do, the auditors will have to reconstruct their financial performance since inception. This will take longer and cost a lot more money than necessary.
The best practice is to recognize that a cost of being a franchisor is having your books run like you are a public company. It can be a hard transition from a founder who is used to running a business for their personal financial benefit without regard to how things are accounted for. Audited financials are a much higher threshold and should be thought through from Day One if your goal as a founder is to win at franchising.
Tom Spadea
Tom Spadea is a franchise attorney and founding partner of Spadea Lignana, one of the nation’s premier franchise law firms, representing over 300 brands worldwide, from emerging concepts to elite brands that are household names. Spadea is a Certified Franchise Executive, speaker, author and key adviser to many high-level executives and entrepreneurs in franchising. spadealaw.com, tspadea@spadealaw.com