What FRANdata Thinks

Franchise Lending: Insights on SBA Franchise SOP

June 19th, 2024 by Paul Santomauro


In our recent deep dive into franchise underwriting, we examined the SBA SOP  to uncover how prudent lending and franchise underwriting intersect. What stood out is the ambiguity surrounding the term “prudent lending.” The SOP mentions prudent lending but lacks a detailed definition, which can be frustrating for lenders navigating these waters.


Unpacking Prudent Lending

We found that while prudent lending is referenced, it lacks specificity. The SOP emphasizes that lenders should adhere to “commercially reasonable and prudent practices”, akin to those used for similar-sized non-SBA guarantees. This leaves a lot open to interpretation and underscores the need for lenders to rely on their expertise and judgment.


Lending in the Franchise Sector

When it comes to franchise loans, the SOP provides more concrete guidance. It specifies that lenders must review credit information, such as the number of failed franchisees and cash flow projections provided by the franchisor. This information is crucial in evaluating the viability of a franchise loan. Additionally, the SOP outlines that independent reports, such as franchise assessment reports, can be beneficial in identifying and mitigating credit weaknesses.


Emerging vs. Mature Brands

A key aspect of our analysis is distinguishing between emerging and mature franchise brands. Emerging brands are defined as those with fewer than 50 franchise units and less than five years in the business. These brands typically have less performance data available, making it harder to assess their creditworthiness. Conversely, mature brands have more extensive performance histories, which provide a more reliable basis for evaluation.


Evaluating Franchise Performance

To assist in this evaluation, we created a fund report that functions similarly to a FICO score for franchise brands. This report looks at both qualitative and quantitative measures at the unit and system levels. For emerging brands, the report focuses on available information, even if it is less comprehensive. We’ve developed these reports to help lenders understand the performance and risks associated with different franchise brands.


Importance of Independent Risk Analysis

Our independent risk analysis- the FUND Report, evaluates franchises across 12 categories, with a maximum score of 950 points. A score of 750 or higher typically indicates top-tier franchise credit. This analysis helps lenders determine their credit appetite and the types of deals they should pursue. It’s essential for lenders to understand these scores and how they align with their institution’s credit standards.


Sector-Specific Insights

It’s important to note that top-performing franchises are not limited to large national food brands. Sectors like early childhood education, with brands such as Goddard and Primrose, also show strong performance. Understanding the diversity of high-performing franchises across different sectors can open new opportunities for lenders.


Navigating the complexities of franchise lending requires a combination of regulatory knowledge, independent assessments, and sector-specific insights. By leveraging detailed fund reports and understanding the nuances between emerging and mature brands, lenders can make more informed decisions and better manage risks while being able to comply with the SBA SOP.


For further insights and to explore our fund reports, join our upcoming webinars and stay ahead in the franchise lending market.


If you have any specific aspects or additional points you’d like to include in the blog post, please let me know!

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