Rising costs, SBA rule changes, and a more cautious lending environment are converging to create real challenges in franchise financing. Access to capital is getting more complex—and your franchisees may soon feel the effects. At a recent lender conference, where close to 400 SBA lenders gathered, it became clear that lenders are tightening their credit standards, increasing scrutiny, and adjusting underwriting requirements in response to these pressures.
Firstly, Why So Many Changes?
Every four years, SBA policy shifts with the changing administration. This time is no different. But while SBA priorities change, FRANdata remains a constant for franchisors and lenders, providing stability in an ever-changing environment.
Here’s what’s driving the current SBA shake-up:
- Over the past three years, the SBA has collected virtually no fees on 85% of its portfolio.
- The result? An increase in SBA payments on failed loans, putting the program into a net operating loss for the first time since the financial crisis.
- Early default rates—businesses failing within the first 18 months—have risen every month and are now at 1.4%, well above the historical average of 0.6%–0.8%.
- Meanwhile, 7(a) lending volume is up 40% year-to-date, adding pressure on the system.
A lender at the conference summed it up:
“We had first payment default in our portfolio for a roofing franchise. What I don’t know is how much working capital is needed to get through the ramp period. I’m not putting good money into something that may just end up failing.”
Predictions of Changes in the SBA Programs
The SBA is preparing to implement significant changes over the next few months, many of which will impact franchisees seeking funding:
- The definition of a small loan is expected to revert from $500,000 back to $350,000, potentially as low as $250,000.
- Affiliation rules will require a regulatory change, creating more complexity for multi-unit and multi-brand operators.
- A new SOP is expected to be released in 1–2 months, pushing these policy shifts forward quickly.
- Equity injection requirements are coming back for business acquisitions and start-ups, meaning franchisees will need more capital upfront.
- The Score-and-Go underwriting model, currently up to $500,000, will drop to $350,000 or lower. This will reintroduce the requirement for full cash flow analysis on larger deals. FICO has noted that “score and go” is not reliable for loans beyond these thresholds.
- The verification platform that removed lenders’ PLP (Preferred Lender Program) authority may be reversed, restoring decision-making power back to lenders.
- The Franchise Directory is expected to make a comeback of some kind.
- SBA plans to streamline environmental reviews, though specifics are still unclear.
- Personnel reductions and staffing changes will result in slower processing times.
Important to Note: Compliance around policy changes are leaving lenders no time to adjust, so there will be delays.
SBA Scrutiny Is Increasing
With more risk in the system, SBA is ramping up oversight:
- More lenders have been placed on the SBA Watch List.
- For lenders on the Watch List, SBA must review loans before they can be sold on the secondary market, which could create liquidity issues.
- In FY2023, SBA reviewed 2,600 loan files. In just the first five months of FY2024, they’ve already reviewed 3,500 files, putting them on pace for reviewing over 3x more loans than last year – a significant increase in oversight.
- Lenders are facing greater scrutiny if they use Third-Party Lender Service Providers (LSPs). SBA has flagged misleading advertising and issued warning letters with timelines for correction.
- Any lender with rapid portfolio growth can expect to be called in for additional SBA reviews.
- The Office of Credit Risk Management is increasing targeted reviews, especially on lenders with high early default rates.
- Lenders are being cited for failure to perfect security interests and missing tax transcripts prior to closing, with potential IRS delays further complicating closings.
Reluctance to Fund Startups and Discretionary Costs
Many lenders are reassessing their risk appetite and becoming more selective in the deals they’re willing to approve. Compounding this shift is the impact of tariffs and rising costs on development projects. Banks are raising their expectations. Higher-quality borrowers—those with stronger financials, operational histories, and liquidity—are becoming the priority for lenders who need to mitigate increased risk.
- Where lenders previously required a 10% contingency in deals, discussions are now pushing that to 15%–20% to account for cost volatility.
- Post-closing liquidity is becoming a critical factor. If lenders aren’t sure where costs will end up, they want assurance that borrowers have enough of a financial cushion to handle unexpected expenses.
This heightened scrutiny and requirement for larger contingencies and liquidity buffers are likely to spread across the market, making it even more important for franchisors and franchisees to present strong financial packages.
Changes That Have Already Happened
Some major SBA policy changes have already gone into effect:
- SBA’s renewed focus is on funding American manufacturers, with senior leadership touring the Midwest to demonstrate this priority.
- SBA loan applications have also been updated to remove the gender-neutral option—borrowers must now select male or female.
- Policy Notice 14159 (effective Jan 20) mandates that all federal agencies stop providing public benefits to illegal aliens. This directly impacts 7(a) and 504 loan programs.
- Businesses must operate in the U.S., and loan proceeds must benefit U.S. entities.
- Lenders must vet at least 81% of ownership and verify legal status through USCIS.
- Asylum visa holders and DACA recipients are no longer eligible for SBA loans.
- Stock options issued to ineligible owners, even after loans are paid off, are not allowed.
One lender noted:
“We’ve seen applications withdrawn because one of the owners wasn’t a U.S. Citizen, National, or Legal Permanent Resident.”
High-Interest Rate Loans
Franchisees stuck in Merchant Cash Advance (MCA) and factoring cycles are now eligible for SBA refinancing, even though these aren’t technically loans. SBA lenders can now refinance these debts and contractually prohibit franchisees from taking them out again.
As one SBA attorney described:
“MCAs are like heroin—once franchisees are hooked, they want more juice.”