SBA’s Proposed Rule Change Could Negatively Impact Lenders

The SBA Franchise Directory is a list used by lenders that contains franchises and other brands deemed eligible for SBA financial assistance. The Directory only includes businesses reviewed and determined as eligible by the SBA under their affiliation rules and other eligibility criteria. No SBA loan programs are available for application if a brand is not listed on the SBA Directory. 

The predecessor of the SBA Directory was the Franchise Registry via FRANdata. FRANdata charged franchisors a fee to review the required documentation and submitted it to the SBA. The SBA Directory replaced the Registry in 2018 and is free to lenders and anyone needing access to the franchisors listed. The Directory may be accessed via the SBA’s website and is controlled by the SBA. Their review of a small business brand’s documentation (ex: Franchise Disclosure Document, Franchise Agreement, License Agreement, etc.) for approval is also currently at no charge.  

The SBA’s Proposed Rule

SBA published a proposed rule on October 26and opened commentary from lenders and other industry professionals with a deadline on December 27.  It stated, “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.”

Once commentary is closed, the SBA reviews all commentary and then publishes the “final rule” which is included in the SBA’s updated Standard Operating Procedure (SOP). This was last updated on October 1, 2020 and SBA promised to release an updated version very soon.

The Industry’s Reaction

In response, the International Franchise Association (IFA), the National Association of Government Guaranteed Lenders (NAGGL) and many other prominent groups, banks, and suppliers agreed that the SBA Franchise Directory should not be eliminated. 

Feedback from lenders indicates the current process for determining franchise eligibility works well, and it’s unclear why the SBA would threaten to remove the Directory unless it’s due to workforce issues. The major concern is that if the current franchise approval process is eliminated, some lenders may be discouraged from funding franchises and small businesses since the determination process would be reassigned as their responsibility, thereby re-introducing added risk to the bank.  

This would not only limit the number of lenders participating in franchise lending but would also likely significantly increase the turnaround time for an SBA loan approval. For example, franchisors would have to address concerns raised by lenders on a loan-by-loan basis, as opposed to being able to resolve eligibility issues directly with SBA on a one-time basis. These issues could result in borrowers being unable to obtain the financing necessary to start or grow their businesses. 

While lenders already routinely assess the operations and qualifications of a loan applicant for compliance with the SBA’s Standard Operating Procedures’ requirements, this determination is different when a franchise (or similar) agreement is involved. This is because such agreements would be used on a much broader basis, with all franchisees operating under a particular brand being subject to the same requirements. 

Potential Impact on Small Business Loans

For franchise applicants, this change would mean there would be no consistency from lender-to-lender or loan-to-loan regarding determining whether basic eligibility criteria are met. If SBA decides to remove franchise and license agreements as a basis for finding affiliation, it will allow all franchise businesses to be eligible.

Many industry associations agree that SBA should continue to review franchise agreements to identify potential ineligibility and continue to use the Franchise Directory as the tool for sharing with lender franchise identifier numbers and any brand-specific eligibility issues.

At FranFund, we believe the SBA Directory is unlikely to be eliminated. The extensive commentary received by the SBA concurs. Reassigning the risk of eligibility determination to lenders would negatively impact SBA lenders’ ability to fund small businesses. It would also prevent franchisors and franchisees from getting SBA funding in a timely manner.