FDD Item 1: The Franchisor and Any Parents, Predecessors and Affiliates
FDD Item 1 is the section of the Franchise Disclosure Document where franchisors must disclose information about who they are, the franchised business opportunity they are offering, and corporate information that includes the franchisor, and the franchisor’s affiliates. Item 1 also includes disclosures about the market in which the franchised business operates, whether or not the business is seasonal and any laws, rules, or regulations that are specific to the development or operation of the franchised business. Item 1 is where prospective franchisees learn about a franchisor’s corporate structure and corporate history.
Whether you’re a new franchisor or a seasoned franchise veteran, you probably have a good idea about how important the Franchise Disclosure Document (FDD) is for the success of your franchise system. After all, franchisors cannot legally offer or sell franchise opportunities in the U.S. without it.
Although the FDD is a complex and often intimidating legal document, it’s important to remember that its purpose is to provide prospective franchisees with enough information to evaluate the benefits and risks of buying into your franchise system. Containing 23 legally mandated disclosure sections, the contents of your FDD should comply with federal franchise laws while effectively communicating the value of your franchise system to prospective buyers.
Below, we’ll explore the mandated disclosures in Item 1 of the FDD so you can better understand their role in helping franchisee candidates access important information about your franchise offering.
Under the Federal Trade Commission’s (FTC) Franchise Rule, which guides the disclosures contained within the FDD, Item 1 requires the disclosure of the franchisor’s identity.
According to the FTC Franchise Rule Compliance Guide, a franchisor is defined as “any person who both grants a franchise and participates in the franchise relationship post-sale.” In addition to their name or names, franchisors are also required to disclose the type of business organization their franchisor company operates under (for example, a corporation, partnership, limited liability company, etc.) and their principal business address.
The disclosure of this information can help prospective franchisees gain a full understanding of the individuals and entities they will be doing business with before buying into a franchise system.
Agent for Service of Process Disclosure
In addition to the identity of the franchisor, Item 1 also requires franchisors to identify their agent for service of process (sometimes referred to as a registered agent). This should include the agent’s name and principal business address.
Under the amended Franchise Rule, franchisors are required to disclose any parent companies with which they are affiliated. According to the Franchise Rule Compliance Guide, a parent is defined by the FTC as “an entity that controls another entity directly, or indirectly though one or more subsidiaries.” All parent entities in the ownership chain should be disclosed, including the identity and principal business addresses of each parent.
Unlike parents, disclosures related to affiliates in Item 1 require more detailed information. In addition to disclosing the identity and principal business address of affiliates, franchisors are required to disclose their affiliates’ business backgrounds, involvement in other types of businesses and the length of time they’ve sold franchise opportunities.
The amended Franchise Rule requires franchisors to disclose any predecessor of their franchise during the ten-year period immediately before the close of the franchisor’s most recent fiscal year (this is also a requirement for Items 3 and 4).
According to the Franchise Rule Compliance Guide, a predecessor is defined by the FTC as “a person from whom the franchisor acquired, directly or indirectly, the major portion of the franchisor’s assets.” In order to meet this definition, it’s necessary that the predecessor operated the same, or a similar, business and that the new ownership purchased operating assets from the predecessor.
It’s important to note that a change in ownership doesn’t necessarily mean the previous owner should be considered a predecessor. Under the Franchise Rule, a former owner should be disclosed as a predecessor only if the new ownership acquired a majority of the franchisor’s assets from its previous owner.
Like parents and affiliates, disclosures about predecessors can help prospective franchisees gain a clearer picture of the history of the franchise system and the individuals and entities that have been involved in its development.
Principal Business Address Disclosure
As outlined in the above sections, franchisors are required to disclose the principal business address of the franchisor and all of its affiliates, parents and predecessors in Item 1. However, the definition of a principal business address can often be confusing for new franchisors that might want to include a private mailbox or a similar alternative to a physical address.
According to the FTC Franchise Rule Compliance Guide, the principal business address is defined by the FTC as “the physical address of the home office in the United States.” This definition does not include post office boxes, private commercial mailboxes, private mail services or email addresses.
Disclosure of the principal business address can help prospective franchisees verify a potential franchisor’s identity and ensure their business operations are legitimate.
Applicable Government Regulations Disclosure
While the amended Franchise Rule doesn’t require franchisors to disclose laws that apply generally to all businesses, such as labor laws or business licensing laws, franchisors are required to disclose any laws that specifically apply to the franchised business being offered.
These Item 1 disclosures include laws that apply specifically to the franchised business’ industry and operations, such as industry-specific licensing requirements, environmental regulations, or any other industry-specific regulations.
Under the Franchise Rule, FDD disclosures must be provided in plain language. Because of that, it isn’t necessary to include specific statutory citations in Item 1. Instead, you should plainly disclose the fact that specific regulations exist that will apply to the franchised business and advise prospective franchisees to conduct further research.
If you’re ready to get started on your FDD – and your journey as a franchisor – we’re here to help! Contact us to learn more about the services we offer, including FDD development for new and experienced franchisors.
Learn more about the Items in the FDD here.