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A franchisor’s financial statements are one of the most important disclosures a prospective franchisee receives before deciding whether to invest. Under the Federal Trade Commission’s Franchise Rule, the Franchise Disclosure Document (FDD) generally must be delivered at least 14 calendar days before a prospective franchisee signs a binding agreement or makes a payment. As of 2026, Item 21 remains the section that establishes what financial statements must be included and when those statements must be audited.
FDD Item 21 is the financial statement section of the disclosure document required by the FTC Franchise Rule. Its purpose is to give prospective franchisees financial information they can use to evaluate the franchisor and identify trends before committing capital. The FTC requires the statements to be presented in a format comparing at least two fiscal years. The requirement is disclosure-oriented: an audit does not guarantee that a franchisor is profitable or financially strong. Rather, independent examination of the statements gives users greater confidence that the information has been prepared under recognized accounting and auditing standards.
For an established franchisor, Item 21 requires balance sheets for the previous two fiscal year-ends and statements of operations, stockholders’ equity and cash flows for each of the previous three fiscal years. The required franchisor financial statements must generally be audited and presented comparatively. Separate financial statements may also be required for a subfranchisor and for a parent that performs post-sale obligations or guarantees the franchisor’s obligations. An affiliate’s statements can sometimes replace the franchisor’s statements when the affiliate absolutely and unconditionally guarantees the franchisor’s obligations and the required guarantee is included with the disclosure document.
The statements generally must be prepared under U.S. GAAP, or another accounting framework permitted under applicable SEC provisions, and audited by an independent certified public accountant using generally accepted United States auditing standards, or U.S. GAAS. The FTC also requires the auditor to satisfy U.S. independence standards. Independence means more than having a different company name: the auditor must remain objective and independent in fact and appearance and avoid relationships or services that compromise that independence. For foreign franchisors, SEC-permitted accounting alternatives may be available, but the FTC still requires the audit to follow U.S. GAAS.
The financial statements help a prospective franchisee look beyond brand growth and unit counts. Balance sheets show cash, debt, assets and obligations at specific dates. Statements of operations show whether the franchisor is generating profits or losses, while cash flow statements can reveal whether operations actually produce enough cash to support the business. Changes in equity can provide additional clues about losses, distributions or capital contributions. In Financial Due Diligence, readers should also examine footnotes, related-party activity, debt maturities and any going-concern language. Comparing multiple years can reveal financial trends that a single year might obscure.
Weak financial results do not automatically violate federal franchise law, but they remain visible to prospective franchisees and may receive additional scrutiny from state franchise regulators. A prospect should investigate recurring losses, negative equity, declining cash balances, significant debt and going-concern disclosures rather than relying on revenue alone. Missing required statements are different: the franchisor must satisfy the applicable disclosure requirements before relying on the FDD. Start-up systems can qualify for a three-year federal phase-in, beginning with an unaudited opening balance sheet, but audited statements must be prepared as soon as practicable. Issues such as Legal Fees and Transaction Costs Deductions should be evaluated separately with appropriate tax and legal advisers.
Under the federal phase-in rules, a new franchisor without existing audited statements may use an unaudited opening balance sheet during its first partial or full fiscal year selling franchises. In the second fiscal year, it must provide an audited balance sheet opinion covering the end of the first fiscal year. Beginning in the third fiscal year, it must provide the full set of required statements, including previously audited periods that remain within Item 21’s reporting window. State requirements can be more restrictive, so the federal phase-in should not be assumed to resolve every state registration requirement.
For more than four decades, Bennett Thrasher has provided businesses and individuals with strategic business guidance and solutions through professional tax, audit, advisory, and business process outsourcing services. Contact Bennett Thrasher’s Financial Reporting & Assurance practice or call us at 770.396.2200.
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