Let’s say a business has a thriving flagship company store Bob’s Subs, LLC, with a successful track record spanning 5 years.  Now the business wants to franchise the concept and sell the system to expand the Bob’s Subs brand. 

We recommend that franchising activity is not conducted under Bob’s Subs, LLC. Instead, we recommend that franchisors set up a new entity, such as “Bob’s Subs Franchising, LLC.” 

Why do we recommend setting up a new entity? 

First, franchising is its own business, separate from the Sub shop that a business operates. Liability will be contained within each separate business so long as each business is operated separately. Therefore, if there are any claims against one business it would not normally impact the other business.

Second, a franchisor will need, at some point, audited financial statements. Depending upon which state a franchisor starts to franchise in, it may need financials in the first year. But at least by the second year, almost all franchisors will need audited financials. 

 An audit of the last three years of transactions for Bob’s Subs, LLC can be very expensive. Instead, we recommend making an opening deposit into a bank account for Bob’s Subs Franchising, LLC and having that audited. An audit of a single transaction will be quick and inexpensive. 

How should the franchising entity be structured?

The new entity should be owned by the same people who own the original company store, (i.e. Bob’s Subs, LLC) so it is a “sister” company to the original entity.  This helps to avoid the position that a consolidated audit will be required under Generally Accepted Accounting Principals (“GAAP”).