Understanding the FDD Item 1: Franchisor’s Background

You’ve got to start somewhere. For franchisors creating their FDD, and for prospective franchisees vetting out a potential investment, it all starts with Item 1.

As can be expected, the first item of 23 is more of an introduction than anything else. The Federal Trade Commission’s Compliance Guide explains that Item 1 of the FDD, “…requires franchisors to disclose background information on the franchisor and any parents, predecessors, and affiliates.”

The Item 1 will contain a basic background on the company, and detail any companies affiliated with the business. It will include some basic information such as the address where the company is headquartered, when they began franchising, if they were known by any other names or changed ownership, a description of the product or service they offer, and regulations related to the business opportunity.

So, since most prospective franchisees will likely have incorporated most of this into their due diligence process, what should they be looking out for in Item 1?

Charles Internicola is the managing partner and founder of The Internicola Law* Firm, P.C., a specialized business and franchise law firm that assists and represents start-up, emerging and established entrepreneurs throughout the United States.

“From a due diligence process, Item 1 is one of the least helpful provisions,” said Internicola. “A lot of the information is generalized information. However, it’s interesting because if there are anomalies within the franchise system, they could be disclosed in Item 1.”

“The area that you’d have to focus on the most in Item 1 is on disclosures about predecessors and known entities,” said Internicola. “A predecessor could be a related or non-related company. If you saw they sold a significant number of franchises or licenses, that could mean there may have been trouble with a previous franchisor.”

Similarly, Ardag Tachian, a franchise development veteran and the Director Franchise Recruitment at Hungry Howie's Pizza, believes that most of the information contained in Item 1 will already be known to the franchise prospect. But it’s important to read through it with an eye for anything that doesn’t line up with what the prospective franchisee expects.

“Basically, on the franchisee side, you’re really looking at the description of the franchise, what the franchise does, the type of service it may provide, and to really have an understanding of what the business is focused on,” said Tachian. “Secondarily, the Item 1 serves as a way to look at the company’s prior experience,” said Tachian. “Do they have experience doing this with other brands? How long have they been doing it? Hungry Howie’s has been franchising since 1982 – so there’s 40 years of franchising which indicates a seasoned business, and decades of learning. Length of time suggests stability.” said Tachian.

However, Internicola said that if the Item 1 checks out, then the franchise prospect should make sure to spend the bulk of their time on other items related to performance of the franchise concept and financial disclosures.

“If you took every item in an FDD, then Item 1 is barely glowing on a heat map whereas Item 19 would be red hot,” said Internicola.