SBA-backed loans have long been an important source of funding for many franchisees, but in the past several years, the system has been in flux. Changes will again be implemented on Jan. 1, 2018, and franchisors should ensure they are ready.
By way of background, franchisees seeking SBA-backed lending are at a disadvantage to other small businesses because of how the SBA views the “affiliation” between franchisors and franchisees. Certain provisions that are common in franchise agreements are viewed as overly restrictive on the franchisee’s right to independently reap a profit from its business and as creating an affiliation between franchisor and franchisee. The SBA then views the franchisor and franchisee as one economic entity, often disqualifying the franchisee from SBA-backed lending. The affiliation issue is typically overcome by amending the franchise agreement on the points that create “affiliation.”
For many years, to avoid the affiliation issue and to facilitate SBA-backed lending to its franchisees, franchisors went through an optional SBA registration process facilitated by a third-party vendor, FranData. That process included reviewing the franchise agreements, negotiating an addendum to waive any franchisor rights that would create affiliation, and registering the form of franchise agreement and addendum with the SBA. While not cheap, the process worked well with relatively quick turn-around times — until the past few years. More recently, the application process began to slow, with processing times frequently exceeding six months. The familiar SBA review process came to an abrupt halt when, effective Jan. 1, 2017, the SBA introduced a required, standard form of SBA addendum that the SBA required all franchisors to use for franchisees seeking SBA loans. The standard addendum was almost immediately criticized for being vague and for not fitting certain franchise systems. The SBA took the critique to heart, and already in mid-February this year permitted franchisors to revert to using previously negotiated SBA addenda, if they would certify that their current form of franchise agreement did not affect “affiliation” between franchisor and franchisee. This was a welcome change, but still left some uncertainty, for example, about how long the alternative would remain an option.
On Oct. 13, 2017, the SBA announced the most recent change to its approval process. It appears to be a mix of the old, familiar registration system, with the new standard SBA addendum. Some of the changes introduced in 2017 will remain in place: franchisors will still be able to choose between using the standard SBA addendum to their franchise agreements and their previously negotiated SBA addenda. However, there are also significant changes. The SBA is reintroducing a franchisor registry, though now it will be managed by the SBA itself. For franchisors, being on that registry will be a prerequisite for their franchisees being able to obtain SBA loans. The criteria for being on the registry are the same as under the old FranData registry: The franchisor must meet the eligibility criteria, and the agreements the franchisee will sign with the franchisor must not create “affiliation” between them. However, while being on the old registry signaled that the SBA had actually reviewed the franchisor’s agreements to confirm no franchisor-franchisee affiliation, that is no longer necessarily the case. For already registered franchisors, the SBA will no longer review their franchise agreement. Instead, franchisors that believe their agreements do not require an SBA addendum or who wish to use a previously negotiated addendum must annually certify that no changes to their franchise agreement have triggered the need for an addendum or triggered a need to revise the previously negotiated addendum.
At this time, franchisors whose franchisees are interested in SBA-backed lending need to take some steps to ensure that this resource will be available to their franchisees, come the new year. The first step is to ensure that the franchisor is listed on the SBA’s registry and that the registry correctly identifies the form of SBA addendum (if any) it will be using. Assuming no addendum is required or the franchisor wishes to use a negotiated addendum, the first annual certification will be due no later than April 30, 2018. A franchisor who wishes to use a negotiated addendum but that has changed or will be changing its franchise agreement will have to resubmit its franchise agreement to the SBA for review.
At first glance, the new approval process appears to strike a good balance for franchisors, but as with so many things, the proof is in the pudding. It is uncertain how long the SBA review process will take for franchisors getting their first negotiated addendum or for franchisors who may need a revised negotiated addendum. Especially for new franchisors who are new to SBA financing, it is possible that the requirement to be on the SBA addendum will cause hardship, unless the SBA will prove to be very swift in updating the new registry.