The past year was an adjustment period for lenders, as they’ve had to vet the eligibility of franchise brands without the help of the U.S. Small Business Administration’s Franchise Directory.
In April 2023, the SBA published a new rule eliminating the directory, with it taking effect in May. Established in 2018, the directory was a running list of franchises and business models that met eligibility standards for financing.
With the directory, banks and lenders could check if a franchise was listed, rather than go through a full vetting process for affiliation and eligibility. Edith Wiseman, president of the franchise research firm Frandata, said the SBA was looking to streamline the lending process after the rollout of the Paycheck Protection Program.
“The SBA felt that the PPP program was such a success that what they wanted to do was basically try and apply what they learned from there to the standard SBA loan,” Wiseman said. “One of the simplifications was trimming down the procedures for SBA loans, and in doing so they changed the regulation that applied to affiliations.”
Edith Wiseman is the president of Frandata.
Because affiliation applied to the contractual agreement between franchisor and franchisee, the SBA was vetting franchise deals. With the affiliation factor dropped, Wiseman said lenders had more freedom, but less structure.
“It’s an overarching, major change that has caused a lot of turmoil within the SBA lending industry,” Wiseman said. “The challenge, from a lender’s perspective, is many don’t conventionally do small business loans, which is why they go through the SBA, and with franchising, they relied on the franchise directory.
“So, if a franchisor was offering CBD as part of their product mix, the SBA would look to see how much CBD is there,” Wiseman said. “If the franchisor was going to take a first lien on assets, the SBA would opine on that. Those are some eligibility examples. Without the directory, lenders have to do that vetting of eligibility on their own.”
Mike Rozman, a lending expert and CEO of financial technology company BoeFly, said those experienced in working with franchise brands have been able to make the adjustment well.
“There are lenders who are meaningfully invested in franchising and focused on supporting franchisees with financing who are navigating it appropriately,” Rozman said. “They know which brands are right for SBA lending, and that hasn’t changed significantly. I think the lenders who maybe aren’t active franchise lenders are probably in more of a challenging situation.”
For those lenders, Wiseman said the strategy has varied. Some are putting a moratorium on any new franchise brands and only lending to those that were on the directory before it was ended. Others have developed their own eligibility checklist for franchisors to fill out.
“One of the items on those lists is whether the lender would be responsible for taking over a franchise location,” Wiseman said. “That’s one thing they should be concerned about. Some lenders have also just hired attorneys to review the franchisor.”
To assist lenders in making the vetting process easier, Frandata created its own compilation of eligible franchises. Wiseman said the firm established a certification to ensure a franchise meets SBA lending eligibility.
“It lists nearly 30 different eligibility issues that the franchisor complies with,” Wiseman said. “It helps lenders have that knowledge, and more specifically if they need to get additional documentation because of the uniqueness of the franchise model.”
Franchisors can get a certification by being part of Frandata’s Franchise Registry system. Wiseman said there are 400 franchisors on the registry now, and that it’s accessible to lenders for eligibility review.
BoeFly CEO Mike Rozman.
Along with shift in the last year following the directory’s elimination, lenders have also had to deal with higher interest rates. At BoeFly, Rozman said franchisors have noted how the higher rates in response to ongoing inflation have proved to be another roadblock.
“We do a survey every quarter of franchise executives and they definitely have reported that the high interest rates have had a negative impact on franchise growth,” Rozman said. “From our point of view, we work with brands that are growing, and they’re finding franchisees that want to open and grow. What I think these franchisees are doing is modeling out their interest expense.”
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Rozman said potential owners have been more deliberate in studying whether a project is profitable at a higher interest expense before getting an SBA loan.
“Assuming the underlying economics support it, they’ll move ahead,” Rozman said. “I think there’s optimism that rates will come down, too, and the nice thing about SBA lending is it resets quarterly. These rates aren’t at historically high levels either. We’re probably more at historic mid-levels. It just so happens we went through a very long period of extremely low rates.”