September 14, 2015
By Walter H. McLaughlin
Coleman Report Contributor
Senior Vice President/SBA Manager
5 Things to Consider When Making an SBA Franchise Loan
Every good business model recognizes the need for balance between supply and demand. In the SBA world, franchise lending is a microcosm of that basic economic principle.
A 2014 International Franchise Association (IFA) Educational Foundation report cited franchise growth as outpacing that of the U.S. economy, projecting it will continue to do so for the immediate future. With demand on the upswing, the need for capital should remain strong.
From a supply perspective, the SBA has always been a popular vehicle to finance franchise ventures. When done properly, loans to franchises create jobs, boosts the economy, enhance profitability and minimize risk.
Sounds perfect, right? Well, the real world doesn’t always match economic theory. As we all know, franchise lending has its specialized set of factors to take into account. To avoid problems now and down the line, consider the following five issues:
- Franchise Eligibility: The Franchise Registry and Franchise Findings reports are keys to determining whether or not the franchise in question has passed the SBA’s filters and should be checked as soon as possible. The SBA offers its own process as well, but it has been hampered by long turnaround times. On that note, Associate Administrator of Capital Access, Ann Marie Mehlum, promised “significant” changes to simplify franchise eligibility at the August, 2015 America East conference in Baltimore.
- Franchisor Due Diligence: Simple eligibility isn’t enough. Is the franchisor new or well-established? Will the borrower be situated in a proper location, and is there a demonstrated need for its products or services in the local market? Is the franchisor in good shape, both legally and financially? Consider obtaining the performance records for each franchisor, information which can be ordered from https://colemanreport.com/shop/2015-franchise-coleman-report/ .
- Royalties: SBA prohibits “excessive” continuing fees imposed by the franchisor. It also encourages the lender to obtain an agreement with the franchisor allowing access to the franchisor’s books and records, deferring ongoing royalty and advertising fees on payment default, providing the lender 30 days notice of a franchise termination and providing the lender the opportunity to cure a default under the franchise or lease agreements.
- Applicants that operate under franchise development agreements (“Master Franchise Agreements”) are considered inherently speculative and are therefore ineligible. Area development agreements, on the other hand, may be eligible.
- The SBA is watching: The PARRiS report template provides a number of potential flags, which the SBA can cite as risk factors to keep in mind. If aggregate loan balances exceed 10% of your overall SBA portfolio, franchise lending will be one of them.
Proper vetting and a little due diligence will go a long way toward keeping your franchise lending in good shape. As with almost everything in life, moderation is the key. As Roman Statesman, Lucius Anneaus Seneca, once said, “The heart is great which shows moderation in the midst of prosperity.”