Best Practices: Franchise Lending Tips for SBA Lenders

SBA has dramatically changed the way lenders process franchise loans under the SOP 50 10 7.1 (“SOP”).  Lenders no longer need to review franchise documentation for affiliation in determining franchise eligibility.  SBA stopped updating its SBA Franchise Directory over a year ago, which previously confirmed eligibility for Lenders contemplating SBA financing to a proposed franchise concept.  So, what does an SBA lender need to do today when closing a franchise loan?

1. Don’t panic. Determining eligibility of a franchise loan under the SOP requires a more focused analysis than under previous versions of the SOP 50 10.   Instead of analyzing agreements for elements of control, a lender now reviews for eligibility, specifically determining whether the franchise concept falls into any type of ineligible business.  See 13 CFR 120.100, 13 CFR 120.110 and 13 CFR 113.3.
2. Focus on the numbers. The sole franchise underwriting requirement in the SOP states lenders must review any credit information provided such as the number of failed franchisees and cash flow projections provided by the franchisor.  This information is typically found in the franchisor’s Franchise Disclosure Document, which also details fees and initial investment amounts for the franchise concept.
3. Read the documents. Franchise documentation is voluminous, but these agreements contain specific requirements that directly impact your applicant’s ability to operate its business and may contain provisions that affect a lender’s loan collateral and rights and remedies to seize collateral in the event of a loan default.
4. Act prudently. Be sure to have fully executed and dated franchise agreements, along with all applicable exhibits and addenda prior to initial loan disbursement.  Remember, these agreements grant the right for your applicant to operate a branded business, if they are not fully executed by the time of loan disbursement, your applicant has no right to open its doors for business at loan closing.
5. Document your file. Add details to your credit memo justifying your decisions.  Be sure to incorporate requirements from the franchise documents into your credit analysis (i.e. discuss why you approve a shorter term for the franchise agreement than the loan term, list any external franchise resources your institution relies upon in making its franchise loan approval decisions, incorporate the franchisor’s stated fees into the cash flow analysis, reference the SBA’s previously issued Franchise Directory as a starting point for your eligibility determination.)

It is unclear how SBA will review franchise eligibility in the context of guaranty purchase under the SOP.  Lenders should take care to perform their franchise due diligence as prudently and thoroughly as they would for any other loan request where there are material contracts that directly impact the applicant’s business.  For assistance with franchise eligibility determinations, please contact us at info@starfieldsmith.com.