Franchise Disclosure Document: Item 2

When entrepreneurs embark on the journey of finding the right franchise concept for them, there is no better resource than a brand’s franchise disclosure document (FDD). The FDD is a legal document broken up into 23 Items ranging from information about required investments to outstanding litigation. Because of the length of the document and the language used therein, reading an FDD can be overwhelming for potential franchisees. To help break down what prospects can expect, 1851 Franchise is detailing what each section entails. Item 2, for example, covers “the identity and business experience of key persons.”

While this may sound simple, Item 2 comes with several other questions: Who are these key persons? What comprises an “identity”? What constitutes business experience? Is it experience related to business in general or to the business of the franchise in particular? What period of time is covered in the examination of the business background of key persons?

According to The Compliance Guide of the FRANCHISE RULE 16 C.F.R. Part 436, which offers very specific guidance on who should be included in Item 2 and what kind of history should be provided, each FDD must disclose: “the business experience of certain individuals – including directors and principal officers, among others – for the last five years. A longer period is acceptable if the prior experience is directly relevant to the franchises being offered for sale.”

In addition to disclosing the business background of directors and principal officers, franchisors “must disclose the business experience of any individuals — even if they do not have a formal title — who have management responsibility relating to the sale or operation of franchises offered by the disclosure document. It does not matter whether the individuals with management responsibility are employed by the franchisor, an affiliate, or by a parent company. As long as the individual actively manages the sale of franchises or the operation of franchises, that individual’s business experience should be noted in the Item 2 disclosure.” 

The franchisor does not need to disclose information about all managers, but all sales and operations managers, regardless of whether they have a formal title, should be disclosed if “their involvement in either sales or operations is such that a prospective franchisee would rely on their expertise, formulation of policy, or control of the system in making an investment decision.”

Similarly, franchisors do not need to disclose information about the business experience of any broker that may be involved in sales of its franchises.

While each member of the executive team will be required to provide a brief biography of their background, candidates should be prepared to search any of these individuals on Linkedin to better understand their background. Brand executives may be selling themselves as one thing, but may be very different in reality.

Overall, FTC.gov recommends that potential franchisees pay attention to the key person’s general business background, their experience in managing a franchise system and how long they’ve been with the franchisor. The leadership team will play an integral role in the success of the brand, which means they will also have a major impact on the success of the franchisee. Before investing in a concept, entrepreneurs need to do a deep dive into Item 2 and the background of the leadership team to ensure the team has the foundation and experience to help them achieve their goals.