Well… we saw this coming for franchise lending. What we alerted you about in our last communication is about to happen. SBA will no longer be in the business of determining franchise affiliation. The deadline for the comment period is December 27th, 2022. Read the proposed rule here – https://www.federalregister.gov/documents/2022/10/26/2022-23167/affiliation-and-lending-criteria-for-the-sba-business-loan-programs
“SBA proposes to remove paragraph (f)(5), affiliation based on franchise and license agreements. Because SBA is removing the principal of control of one entity over another from its affiliation consideration, this paragraph is no longer needed. Upon the effective date of this rule, SBA would no longer publish the SBA Franchise Directory. SBA Lenders retain the responsibility for ensuring that the applicant meets all Loan Program Requirements. SBA will continue to collect a franchise identifier number on each loan for the purpose of completing mandatory reporting requirements to Congress and for responding to congressional inquiries.” – excerpt from the Federal Register
The Good News
Franchise affiliation requirements shift to a focus on ownership. That part of the franchise review process for protecting the SBA guarantee will now be more streamlined.
The Bad News
In the process of determining affiliation, SBA also vetted for franchise eligibility issues and once a franchise brand was added to the SBA Directory, both franchise affiliation and eligibility were no longer risks for lenders. It was one review that benefited all lenders. Now franchise eligibility reviews are the responsibility of each lender for each brand, as well as all have observed, which can be tricky and complicated. For instance:
- Any franchise with real estate restrictions or collateral concerns that have been identified in franchise systems across many industries such as gas stations and convenience stores, personnel services, and hotels; the list is long, These issues also were reviewed by SBA and once a franchise brand was put on the SBA Directory it meant both affiliation and eligibility were acceptable by SBA, providing security for lenders and eliminated what would otherwise by a lender by lender interpretation of all relevant franchise documents.
- One of the key reasons SBA took on the responsibility of determining franchise eligibility for all lenders was the inconsistent conclusions and requirements that lenders put on franchisors. It now seems history is about to repeat itself. This was the genesis of FRANdata’s Franchise Registry in the 1990s.
- The existing process deals with basic issues like determining whether a brand is a franchise so further eligibility analysis is needed. That now goes away, making it harder for lenders and will bring into question if and how future franchise loan tracking might be done.
Some Further Details
SBA has proposed and is about to implement a major change in affiliation criteria for franchises and distributorships/ licensees by eliminating current principles for determining affiliation arising from management and control, franchise or license agreements, and identity of interest. Instead, SBA proposes to streamline affiliation determinations based only on ownership criteria. This development will lead to the SBA Franchise Directory being shuttered. While the simplification regarding affiliation is a welcome step for lenders, the elimination of the entire franchise review process is not as it puts the burden on individual lenders to wade through franchise documents to determine if a franchise brand meets program requirements for eligibility.
We are assessing how our deep knowledge of SBA franchise actions/determinations can help lenders solve this shift in risk. FRANdata’s Franchise Registry has adjusted to SBA program changes since the 1990s and is expected to take on yet another expanded function. Here’s an example of what franchisors are saying:
What is clear
When SBA franchise reviews go away and the SBA Directory with it, lenders will have increased review responsibilities and therefore risk that lenders tell us could affect their willingness to lend to franchises, especially for smaller loan amounts (under the average SBA loan size of $400,000). Many lenders will be hesitant to take on sometimes complicated eligibility reviews because SBA is no longer vetting franchise agreements for all eligibility program requirements with the change in affiliation standards.
About FRANdata’s Franchise Registry
The Franchise Registry lists every franchise in the United States. While its primary purpose is to make lenders aware of the existence and viability of a franchise brand, many people, such as prospective franchisees, government agencies, educational institutions, and industry experts use the site to validate that a franchise is an existing and thriving company. Click here to find out more.