The SBA and Your Franchise: What They Want to See

By Michael H. Seid, Joyce Mazero

If you plan to franchise, you will be involved with the SBA. The Small Business Administration (SBA) is a United States government agency with the mission to provide support to entrepreneurs and small businesses. One way it provides this support is by guaranteeing loans made by banks and credit unions to qualifying small businesses.

SBA loans are made through banks, credit unions, and other lenders who partner with the SBA. That is, the SBA doesn’t make loans itself, but rather provides a government-backed guarantee on part of the loan. It has established guidelines for loans that it will guarantee. By guaranteeing that the loans these institutions make to small business will be repaid, the federal government diminishes some of the risk to financial institutions so that they are more likely to consider lending to small businesses — businesses they likely would have turned down without those guarantees.

If you are in the United States and if you qualify, an SBA-backed loan may be a way to obtain a loan not otherwise available. You stand a better chance of success with a certified SBA lender.

Recently the SBA revised its approach to franchisee financing in an attempt to streamline the Franchise Registry. The Registry is an SBA program that lists names of franchise companies whose franchisees can get a streamlined review process. Prior to the SBA’s new program, effective January 2017, the SBA had established an SBA Registry where the agency conducted a review of a franchisor’s franchise agreement and disclosure documents to determine whether its franchisees had sufficient independence as business owners to be eligible for an SBA-guaranteed loan.

Under the SBA’s new program, franchisors and franchisees are required to sign a new SBA Standard Addendum to the franchise agreement that covers affiliation between the franchisor and franchisee. Once the SBA Standard Addendum is signed, the SBA will consider the franchisor and franchisee to be independent parties. In most situations, the SBA’s goal is to no longer need to review the franchise agreement and disclosure documents. The SBA Standard Addendum cannot be modified or negotiated, and it contains the following non-exhaustive list of provisions:

  • Change of ownership: This provision limits the franchisor’s right of first refusal when a franchisee seeks to transfer only a partial ownership interest. Franchisors cannot unreasonably withhold their consent to any transfer, and once a transfer is approved by the franchisor, the selling franchisee will not be liable for the franchise obligations of the buyer.
  • Forced sale of assets: Upon the termination or expiration of the franchise agreement, the franchisor may purchase the assets of the franchisee based on either an agreed-upon price or at an appraised value.
  • Real estate: If the franchisee owns the real estate used for the business, the franchisor won’t be able to record restrictive covenants against the property or force the franchisee to sell the real estate to the franchisor upon default or termination. If restrictions are already recorded against the franchisee’s real property by a franchisor, those restrictions must be removed in order for the franchisee to obtain SBA-assisted financing. But the franchisor can require the franchisee to lease the franchisor the real property for the duration of the franchise term.
  • Employment: The franchisor can’t directly control (hire, fire, or schedule) the franchisee’s employees. For temporary personnel franchises, the temporary employees will be considered to be employed by the franchisee not the franchisor. The addendum doesn’t define the term temporary employees.

There are several other requirements under the SBA’s new program, and the SBA is continuing to revise its policies. For example, six weeks after launching the new program, the SBA issued new policy guidance that offers an alternative to the SBA Standard Addendum for franchisors who, prior to the new program, had finalized an SBA Negotiated Addendum. Now franchisors may elect to use an already existing SBA Negotiated Addendum previously approved by the SBA before the new program, along with an SBA Certification form.

However, the SBA Negotiated Addendum must be an addendum that was developed by the SBA and the franchisor using a 2015 or 2016 version of the franchise agreement. All other franchisors must use the SBA Standard Addendum. Accordingly, the SBA’s new program is a moving target, leaving lenders and franchisors with uncertainty as to likely SBA changes to come.

Several franchisors have stated that they may be unwilling to sign the SBA Standard Addendum. You should check with any prospective franchisor about whether or not they will participate in the SBA’s new program. If a franchisor is unwilling to sign the SBA Standard Addendum, you may not be able to obtain an SBA-guaranteed loan from your lender under the SBA’s current policy. The SBA’s new program only streamlines the process — it’s not a guarantee that you will be able to borrow any money.

The SBA has an application you will be required to complete and a published list of items you will be required to submit to the bank in connection with seeking a SBA backed loan. Much of the information and documentation is the same that’s required to provide a bank, but on SBA required forms. A summary from the website includes the following:

  • The SBA Loan Application.
  • Personal Background and Financial Statement, including forms showing Statement of Personal History, SBA Form 912, and a Personal Financial Statement, SBA Form 413.
  • Business Financial Statements, including for an existing business a current profit and loss statement and for all businesses a detailed projected financial statement, with a one-year projection of income and finances and written explanation as to how you expect to achieve this projection.
  • Ownership and Affiliations. Include a list of names and addresses of any subsidiaries and affiliates, including concerns in which you hold a controlling interest and other concerns that may be affiliated by stock ownership, franchise, proposed merger, or otherwise with you.
  • Business Certificate/License. Your original business license or certificate of doing business. If your business is a corporation, stamp your corporate seal on the SBA loan application form.
  • Loan Application History. Include records of any loans you may have applied for in the past.
  • Income Tax Returns. Personal and business federal income tax returns for previous three years.
  • Résumés for each principal of the company.
  • Business Overview and History, including a brief history of the business and its challenges and an explanation of why the SBA loan is needed and how it will help the business.
  • Business Lease. A copy of your business lease or a note from your landlord, giving terms of proposed lease.
  • If you are purchasing an existing business, the following information is needed:
    • Current balance sheet and P&L (profit and loss) statement of business to be purchased
    • Previous two years federal income tax returns of the business
    • Proposed Bill of Sale including Terms of Sale
    • Asking price with schedule of inventory, machinery and equipment, furniture, and fixtures