For the majority of franchisors, the first quarter of the calendar year is also the first quarter of their fiscal year, and thus the time they focus on updating their franchise disclosure documents. Unfortunately, a simple review of existing documents will not always identify the issues that have occurred in the past year that require disclosure. Thus, for clients for whom we file disclosure documents, we have sent out questionnaires tailored to their business that help them identify policies that may have changed, and agreements that may have been signed, which now must be disclosed.
Last year, the renewal process was more complicated for most companies because they were converting their “UFOC” documents to the new “FDD” format required by federal law. The legal work involved in updating the documents this year should be much simpler, since we have no new registration or disclosure laws with which to comply. However, franchisors may find the state review process to be more onerous this year as the registration states have now had a year of experience with the Amended FTC Rule on Franchising. State regulators have given us some insight into a few areas they will be focusing on this year, most of which relate to a franchisor’s financial statements, an area that saw little review in many states in previous years.
Under federal law, the time to update disclosure documents has increased from 90 to 120 days following the franchisor’s fiscal year. However, under several state laws, including Minnesota, if the franchisor does not file its renewal document within 90 days after its fiscal year end, it is required to include updated interim financial statements as of a date within 90 days of its filing date. Thus, we have recommended to our clients that they continue to focus on March 31 as the deadline for renewing their state registrations.
Several state regulators have reported that franchisors who were previously exempt from their registration requirements because they had a $5 million net worth have now dropped below the net worth threshold, and the states are finding their disclosure documents to be woefully deficient. If you are a company that fits in this category, or represent such a company, you will want to take extra care in being certain your disclosure documents comply with the Amended FTC Rule, because you can expect the states to be scrutinizing your documents.
A couple state regulators have also reported that due to the recession they are seeing significant adverse changes in the financial statements that are being filed with franchise applications, and are thus paying more careful attention to those statements, and the potential for requiring an impound of fees paid to the franchisor before franchisees open for business. While a franchisor cannot change its financial performance after the end of its fiscal year, it should review the draft financial statements received from their auditors before those statements are finalized. It is not unusual that we find footnotes that are inconsistent with provisions of the disclosure documents. In addition, if the franchisor’s net worth has dropped significantly, there may still be opportunities to work with the auditors to capitalize expenses, or take other actions that will improve the net worth of the franchise company.
The other advice we would offer to all readers, as we do every year to our clients, is to start working on the renewal process as early as possible. Much of the year-end information needed to be included in the FDD, particularly in Item 20, is a lot easier to capture close in time to year end than it is three months after the fact. Perhaps even more importantly, renewal applications filed by mid-March will be at the top of the stack of hundreds of renewal applications the registration states receive in March, and are likely to be approved more quickly, thus avoiding lengthy delays in the renewal process.