Financial Information: The Franchise System's Disclosure

Beginning a new franchise can be extremely challenging, making the professional advice of a franchise lawyer invaluable.

Contact Neufeld Legal PC for franchising legal matters at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

When a franchisee is pursuing a franchising opportunity, one of the more significant aspects of due diligence involves a review of the franchisor's financial information related to the franchise system, which must be disclosed in the Franchise Disclosure Document (FDD) as statutorily mandated by provincial franchise legislation (currently in Ontario, Alberta, British Columbia, Manitoba, New Brunswick, and Prince Edward Island).

Where provincial legislation has mandated the disclosure of financial information to prospective franchisees, the principal financial disclosures generally include:

• Franchisor's Financial Statements: The franchisor must provide financial statements for its most recently completed fiscal year. These statements must be prepared on an audited basis or a review-engagement basis (which is a higher standard than a "notice to reader"). They must be prepared in accordance with generally accepted accounting standards in Canada (or equivalent standards). It should be noted that there are exemptions from the requirement to include financial statements for certain large, well-established franchisors or new franchisors who have been operating for less than one fiscal year (the latter may be required to provide an opening balance sheet).

• Costs of Establishing the Franchise (Initial Investment): A comprehensive list of all of the franchisee's estimated costs to establish the franchise must be included. This is a crucial section for the prospective franchisee's investment decision. These costs typically include: initial franchise fees and deposits (including whether the deposit is refundable); estimated costs for inventory, supplies, leasehold improvements, equipment, fixtures, signs, etc.; and any other required payments to the franchisor or its associates.

• Ongoing Payments/Fees: Details of all recurring financial obligations to the franchisor or its affiliates, such as: royalties (and how they are calculated); advertising fund contributions; technology fees and other periodic fees.

• Advertising Fund Disclosure: If the franchisee is required to contribute to an advertising fund, the FDD must include details, often including: a statement of how the fund is administered; disclosure of the amounts spent on various categories for the last two fiscal years and projected spending for the current year [more on advertising funds].

• Rebates and Other Benefits: Disclosure of whether the franchisor or its associate receives rebates, commissions, or other benefits as a result of the franchisee's required purchases of goods or services, and whether those benefits are shared with franchisees.

• Financial Performance Representations (Earnings Claims): If the franchisor chooses to make any representations about actual or potential sales, costs, income, revenue, or profits (often called "earnings claims"), these must be disclosed in the FDD. If made, they must have a reasonable basis in fact and must be accompanied by a statement specifying the basis for the projection, all underlying assumptions, and the location where substantiating information is available for inspection.

• Bankruptcy or Insolvency: Details of any bankruptcy or insolvency proceedings of the franchisor or its officers/directors within a specified period (typically the five-year period immediately preceding the date of the FDD).

In addition to these specific financial requirements, the FDD must disclose all "material facts," which is broadly defined as any information that would reasonably be expected to have a significant effect on the value or price of the franchise or the decision to acquire it. This catch-all can often include specific financial information relevant to the location or market being offered.

Christopher Neufeld is a business lawyer knowledgeable in the rigors and challenges of the franchise business, together with the legal constructs that are critical to their effective operation. For experienced legal representation in starting, acquiring / selling, operating and managing a franchise, contact franchisee lawyer Christopher Neufeld at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or Chris@NeufeldLegal.com.

The Basics to Becoming a Franchisee: Embarking on the path of becoming a successful franchisee demands an incredible amount of time and effort, given that there are only a limited number of truly successful franchisees, with those that have set themselves apart and hit the pinnacle of franchise operations and profitability. This begins with understanding the core concepts of a business franchise. Read more.

 

Contact us via email at chris@neufeldlegal.com or call 403-400-4092 / 905-616-8864.