How to Read a Franchise Disclosure Document: Business Background (FDD Item 2)

The Franchise Disclosure Document (FDD) contains 23 categories, or items, and this article focuses on the second item. “Item 2” pertains to the background of the business. Item 2 describes “the identity and business experience of key persons.” However, this small statement contains many sub-questions. Who are key persons? What comprises an “identity”? What is business experience? It is 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 keys persons?

Ardag Tachian, Area Developer of MOOYAH, notes that “There’s a detailed explanation of the business experience of the company in Item 2. It blends right in from the description of the business and how long it has been around. It addresses the leadership’s background, depth of experience, and so forth. Certainly with the leadership being listed, there is typically a brief biography that’s required but a future franchisee can obviously search any of these individuals online to better understand their background...and have a deeper understanding of who the brand is.”

The Compliance Guide of the FRANCHISE RULE 16 C.F.R. Part 436 offers further very specific guidance on who should be included in Item 2 and what kind of history should be provided:

It requires disclosure of 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. …[F]ranchisors need not disclose information about the business experience of any broker that may be involved in sales of its franchises. Second, 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. This does not mean that franchisors must disclose all managers. Rather, 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.

FTC.gov recommends that potential franchisees to 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.  

Tachian concludes that “The leadership is the rudder going forward for the the brand. If someone is going to be investing hundreds of thousands of dollars in the business, they want to be comfortable with the leadership’s team and if that leadership team has the foundation and experience to help them achieve their goals.”  With this information in mind, franchisors can better formulate Item 2 and franchisees can better interpret it.

Reference Sample Item 2 (From The FRANCHISE RULE 16 C.F.R. Part 436):

ITEM 2: BUSINESS EXPERIENCE President and Director: Jane J. Doe Ms. Doe became President of Belmont Mufflers, Inc., in June 2006. From May 2004 until June 2006, she served as our Vice President. From June 2000 until April 2004, Ms. Doe was Vice President of Atlas, Inc., a Houston, Texas, manufacturer of automobile wheels. Vice President: Henry Moore On July 1, 2006, Mr. Moore joined Belmont as Vice President. From January 2000 until July 2006, Mr. Moore served as a manager of Belmont Muffler Manufacturers, Inc. Franchise Coordinator: Philip E. Smith On January 1, 2006, Mr. Smith joined us as a franchise coordinator. From July 2001, until September 2005, Mr. Smith was a manager at Bishop W ash, Inc., a Denver, Colorado, manufacturer and distributor of car wash detergents. Manager of Franchise Development: Ann Howard Ms. Howard has managed franchise development at our parent company – CFT International, Inc., since 1995. She oversees the development of all franchise systems owned and operated by CFT International, including Belmont Mufflers, Inc.