Over $3 Billion in SBA Franchise Loans Last Year: Why Getting SBA Affiliation Rules and Process Right is So Important

October 13, 2015

Over $3 Billion in SBA Franchise Loans Last Year: Why Getting SBA Affiliation Rules and Process Right is So Important

By Ron Feldman
Chief Development Officer, FRANdata

Before year end, we expect SBA to announce changes to the affiliation standards and the process for determining and communicating determinations to lenders. Over the past few years, franchise lending has substantially increased and interpretations of franchise affiliation reviews such as the affiliate issue now being addressed in the proposed rulemaking have become increasingly burdensome.

Change was needed. Understanding how that change will impact SBA franchise lending will be the key to whether it boosts or constrains franchised small business access to SBA-guaranteed loans.

Three constituencies associated with SBA franchise lending other than the small businesses benefit from such access: the SBA, lenders such as yourself, and franchisors. If the critical needs of all three are not met, franchise lending will be negatively impacted and the tens of thousands of small businesses that rely on this vital source of capital will suffer.

SBA has a critical responsibility of establishing standards that define when the control line has been crossed between a franchisee and a franchisor. It is challenging because the line is embedded in lengthy legal contracts (franchise agreements). As we all know, legal contracts are subject to interpretation, making even a simple affiliation standard sometimes hard to assess across cleverly worded agreements and associated documents.

Lenders have a more straightforward objective. There is a need to document a franchise loan properly to ensure the guarantee is valid relative to affiliation standards associated with the relevant franchise agreement. While preferred lenders always have had the ability make their own franchise affiliation determinations, they have not done so for the same reason SBA has had difficulty: franchise agreements are legal contracts with ample room for interpretation so they have been reluctant to use their authority. As long as someone else makes a valid affiliation determination and the documentation process is easy, they will be satisfied.

That brings us to franchisors. They have two requirements: The ability to negotiate side agreement wording with SBA for approval and control over distribution of the determination and related documentation.

Many franchisors, the IFA and FRANdata included, provided a clear understanding of why these requirements are important during the comment period earlier this year. Franchisors define the legal relationship with franchisees many different ways. When looked at through the lens of affiliation, different solutions exist for terms (often even specific words) deemed problematic by SBA and franchisors believe they should have the ability to negotiate an addendum to their franchise agreements for purposes of qualifying their franchisees for SBA lending.

Further, most franchisors change their franchise agreements from time to time and many have different franchise agreements for different franchise programs (ie. co-brand, non-traditional outlets such as airport, travel plazas, hospitals etc) within a single brand. Many franchisors have different types of agreements for single and multi-unit franchisees and may offer different terms in different geographic regions (for a variety of reasons, including for economic reasons and/or for state regulatory reasons.

In essence, the onus of whether to agree to an SBA affiliation addendum for a specific franchisee must at all times be in the control of franchisors, including the very existence of any addenda. The best way to do so is for franchisors to have control over lender affiliation communications.