Whether you are a franchisor expanding your brand or an entrepreneur pursuing a franchise opportunity, the first legal checkpoint is the disclosure of finances, as mandated by the Arthur Wishart Act (Franchise Disclosure), 2000. This legislation ensures transparency by requiring franchisors to provide a disclosure document that includes specific, accurate, and timely financial statements, shedding light on the complexities of franchise agreements.

Our submission outlines what the law demands, what the legal jargon means, and why it’s essential for both the franchisor and the franchisee to understand these disclosure requirements before entering into a franchise agreement.

Why Is Financial Disclosure So Important in Franchising?

The Arthur Wishart Act seeks to protect often unsophisticated purchasers of franchise rights by promoting transparency and fairness. It levels the playing field between franchisors, who typically have legal and financial resources, and franchisees, often individual entrepreneurs investing personal savings or loans into a franchise system they’re learning to navigate. 

Financial statements offer franchisees a critical glimpse into the franchisor’s financial position, answering key questions: Do they have the resources to support you? Are they profitable? Are they growing? At Cloudhaus Law, we believe franchisees deserve this information to make an informed decision before committing to a franchise agreement.

What Does the Act Specify as a ‘Legal Requirement’?

Under Section 5 of the Arthur Wishart Act, 2000, franchisors must provide a disclosure document to prospective franchisees at least 14 days in advance of signing a franchise agreement or accepting any payment, such as a franchise fee. The disclosure document must contain:

• An audited financial statement, conducted by a licensed auditor following Canadian Auditing Standards (GAAS), or
• A review engagement financial statement, a credible but less intensive review by an accountant using Generally Accepted Accounting Principles (GAAP), or
• A declaration of exemption, if the franchisor meets all four criteria under Section 11 of Regulation 581/00.

The financial statements must be included for the most recently completed fiscal year, unless 180 days have not passed since the year’s end, in which case the previous year’s statements may be used temporarily. The disclosure document must contain every material fact to comply with the disclosure requirements and ensure transparency.

Can You Be Exempt from Providing Financial Statements?

Yes, but only under strict conditions. A franchisor may be exempt from disclosing financial statements if they meet all four criteria under Section 11 of Regulation 581/00:

• A consolidated net worth of at least $5,000,000, or $1,000,000 if controlled by a corporation with a $5,000,000 net worth.
• At least five years in the same line of business.
• At least 25 franchisees operating in Canada or another country during the five years preceding the disclosure document.
• No judgments, orders, or awards against the franchisor, its associates, officers, or directors for fraud, unfair practices, or franchise law violations in the past five years.

If any condition is not met, such as falling below the net worth threshold, the exemption does not apply, and the franchisor must provide full financial disclosure.

What If You’re a Startup Franchisor?

For franchisors who haven’t completed one full fiscal year, the Act allows disclosure of an opening balance sheet, summarizing financial resources and obligations at the time the franchise was established. Though less detailed, this balance sheet is still a critical component of the disclosure document, ensuring franchisees can make an informed decision.

Why Are Financial Statements Required at All?

Financial transparency is the foundation of a fair franchise relationship. Franchisees often make significant investments, sometimes exceeding $100,000, including leasehold improvements and other costs. The law mandates that franchisors provide a complete, honest picture of their financial position so franchisees can assess the viability of the franchise opportunity. This is not just ethical; it’s a legal requirement to protect franchisees.

What Happens If a Franchisor Doesn’t Provide Financial Statements or Gives Incomplete Data?

Under Section 6(2) of the Act, a franchisee can rescind the franchise agreement within two years if the franchisor fails to provide a compliant disclosure document. The franchisor may also be required to compensate the franchisee for losses, including investments, equipment costs, and lost profits due to the failure to comply with the disclosure obligation.

What’s the Difference Between Audited and Reviewed Financial Statements?

Audited financial statements undergo a thorough examination by a licensed auditor, verifying accuracy through testing, sampling, and internal control checks, making them the gold standard. Reviewed financial statements involve a limited analysis by an accountant to check for obvious inconsistencies, meeting standards applicable to review engagements set by GAAP. Both satisfy the disclosure requirements, but audited statements offer greater assurance.

I’m a Franchisor Launching in Ontario but Operate Primarily in the U.S. Do I Still Have to Follow Canadian Standards?

In most cases, yes. However, recent amendments allow financial statements prepared under international standards, like IFRS, if they are substantially equivalent to Canadian standards. Consult a CPA to ensure compliance with Ontario’s disclosure requirements.

If I’m a Franchisee, Should I Hire Someone to Review the Financial Statements?

Yes. A franchise-experienced accountant or lawyer can identify red flags, such as cash flow issues or reliance on franchisee fees, which could indicate risks. This small investment can protect you from significant losses when entering into a franchise agreement. To know more check out The Roadmap of Franchising for a Franchisee.

Can Financial Statements Be Delayed or Updated Later If the Deal Moves Quickly?

No. The disclosure document, including financial statements, must be provided in full at least 14 days before any agreement is signed or payment is made. Rushing or promising to provide financials later violates the Act and may allow the franchisee to rescind the agreement.

What If the Franchisor Is a New Business and Has No Revenue Yet?

New franchisors must still provide an opening balance sheet, detailing initial capital, startup loans, and early expenditures. This offers franchisees insight into the franchisor’s financial starting point, ensuring transparency.

How Often Do Franchisors Need to Update Their Financial Statements?

Financial statements must reflect the most recently completed fiscal year. Franchisors must update their disclosure documents annually after each fiscal year. If more than 180 days pass and new statements aren’t ready, the previous year’s statements may be used temporarily.

What If the Financial Statements Show Losses or Low Profitability?

Losses or low profitability aren’t necessarily deal-breakers but require context. Are losses due to expansion, one-time costs, or ongoing issues that could impact the franchisee’s success? A transparent franchisor will explain these factors to help franchisees understand the franchise opportunity. 

What Happens If a Franchisor Gives False or Misleading Financial Information?

Providing false or misleading information is a serious offense. It can lead to rescission, civil liability, and damages claims. Under Section 7 of the Regulation, franchisors must certify that the disclosure document includes every material fact and contains no untrue statements or omissions. Violations can result in lawsuits and reputational harm.

Transparency Isn’t Just Legal, It’s Strategic

Franchising is a partnership built on trust. When franchisors comply with the disclosure requirements, providing accurate financial statements, they demonstrate credibility and inspire confidence. This transparency helps franchisees make informed decisions, fostering a strong, honest relationship critical to the success of the franchise system.