SBA to Require Franchisors Be Listed on Franchise Directory for Franchisees to Be Eligible for SBA Financing

by Joshua Schneiderman and Susan A. Grueneberg

Effective January 1, 2018, the U.S. Small Business Administration (SBA) will only process loans to fund the acquisition and development of new franchises if the franchisor is listed on the SBA’s new Franchise Directory.

As background, the SBA limits its lending to independent small businesses. If a franchise agreement imposes certain controls by the franchisor over the franchisee that the SBA views as excessive, the SBA will consider the franchisor “affiliated” with the franchisee, which would make the franchisee ineligible for a loan. Prior to January 1, 2017, franchisors would typically negotiate addenda or changes to their franchise agreements with the SBA through FRANdata, a private franchise information services company, to resolve “affiliation” concerns. Having a negotiated addendum enabled a franchise brand to be included on FRANdata’s Franchise Registry, a listing of franchise systems deemed eligible for SBA financial assistance.

In November 2016, in an effort to streamline the process for SBA loan eligibility, the SBA announced it would no longer review franchise agreements and negotiate addenda beginning January 1, 2017. Instead, it would require use of a standard two-page form franchise agreement addendum that a franchisor could use to achieve eligibility. In February 2017, in response to franchisors’ concerns over the form addendum, the SBA modified its eligibility process to permit franchisors, as an alternative, to continue to use addenda negotiated in 2015 or 2016 as long as they also used a certification form provided by the SBA stating that the franchise agreement had not changed since the addendum was negotiated. Franchisors did not need to be listed on the Franchise Registry for their franchisees to be eligible for SBA backed loans, although most franchisors did continue to apply for listing on the Franchise Registry because it was a trusted source of information for lenders.

Last month, the SBA announced changes to go into effect on January 1, 2018. The SBA has created its own Franchise Directory of all franchise brands that the SBA has determined are eligible for financing under its affiliation and other requirements. Starting with 2018, if a franchise system is not on the SBA Franchise Directory, a franchisee’s application for SBA financing cannot be processed. 

The SBA Franchise Directory lists information about eligible franchise brands in four columns:

• Whether the brand meets the definition of a franchise
• The brand’s SBA Franchise Identifier Code
• Whether or not an addendum is required, and whether it is the standard SBA addendum or a negotiated addendum
• Whether there are additional issues the lender should consider

What should franchisors who want their brands to be eligible for SBA guaranteed loans do now?  

Franchisors that had programs that were previously eligible should check the SBA Franchise Directory to make sure their brands are listed.

Franchisors that are listed on the SBA Franchise Directory and that either do not need an addendum or are using a previously negotiated addendum can continue their listings without change if they submit to the SBA an “Annual Franchisor Certification” as soon as they issue an updated franchise agreement, but no later than April 30, 2018. In the Certification, the franchisor must represent that (i) the terms of the current agreement that affect affiliation have not changed, and (ii) if the franchisor is using a negotiated addendum, no changes have been made to its negotiated addendum. 

If a franchisor that has a negotiated addendum wishes to continue to use a negotiated addendum but wants to make changes to its franchise agreement, the franchisor must submit a red-lined version of its franchise agreement, Franchise Disclosure Document and any other documents the franchisee is required to sign as well as the proposed change to the addendum to the SBA for review as soon as possible.

Franchisors who are not presently listed on the Franchise Directory should consider whether eligibility for SBA lending programs is something that is important for their system’s development, and if so, whether they are comfortable signing the SBA’s form addendum. If so, they should contact the SBA as soon as possible to request inclusion in the Directory.