At the end of every year, the Small Business Administration (SBA) releases a new version of their Standard Operating Procedures (SOP) to be implemented in the following year. Usually, this only impacts SBA lenders, as the updates to the SOP rarely affect the day-to-day operations of the franchise community. But in December of 2016, the announcement of SOP 50 10(i) would send shockwaves through the entire industry.
Mostly focused on franchise lending, the new SOPs made dramatic changes to the rules and processes surrounding the franchise relationship for SBA lenders. Gone was the SBA franchise affiliation review process and in its place a standardized “one-size-fits-all” addendum. It also shifted the risk of eligibility determination and other issues from the SBA back to the lender.
In recent years, the SBA franchise affiliation review process had been mired in delays and some franchisors would have to wait months after their latest documents were submitted for SBA approval. The SBA said the changes in SOP 50 10(i) were an attempt to “streamline” these procedures, but the uncertainty created by them was far more than intended.
Now, we are more than half way through 2017, and the confusion surrounding the new SOP remains a topic of discussion. Today, we are going to highlight the most important changes, how to implement them, and what we can expect going forward into 2018 and beyond.
Three Items of Risk
One of the biggest misconceptions people have about the SBA is that it actually lends money. In reality, small business lenders are the ones issuing the loans to prospective borrowers. To incentivize lenders to make these loans, the SBA guarantees to repay a portion of the loan should a borrower default. In order to qualify for this guaranty, the loan and the borrower must meet certain SBA eligibility requirements.
In the past, this meant franchisors wanting to make SBA financing available to their franchisees had to submit their franchise documents for review to the SBA to receive an approval. The SBA would determine if the business met the SBA’s unique definition of a franchise, review for any affiliation issues, and either propose changes to the documents to make them eligible or issue an addendum certifying the eligibility of the franchise. It was this addendum that gave franchise lenders the confidence to lend to a potential franchisee, assured the concept was eligible for the SBA guaranty.
With the new SOP, this approval process and the resulting addendum no longer exist. In its place, a standardized “one-size-fits-all” addendum (Form 2462) the franchisor must sign for each franchisee to certify that they are eligible for SBA lending. Also, task of determining eligibility is shifted to the lender in three specific areas. First, in lieu of the SBA’s unique definition of a franchise, the lender must now determine whether a brand’s business meets the Federal Trade Commission’s (FTC) guidelines for a franchise. Second, the lender must now determine business eligibility. And third, the lender must identify issues and negotiate solutions with franchisors to bring agreements into compliance with SBA requirements.
There was a lot of initial pushback from franchisors about the new addendum. Some franchisors vowed they wouldn’t sign it, swearing off SBA lending. Other brands were angered since they had spent considerable time and money negotiating and creating their addendums with the SBA, and also feared they may now be ineligible.
Lenders were also worried, because with this new process, they wouldn’t know if their determinations on eligibility were aligned with the SBA’s until after a default, and risked their guaranty should they make an incorrect decision.
In an effort to address these concerns, in February 2017 the SBA issued an amendment to the SOP, allowing franchise brands the option to choose either the standard Addendum Form 2462, or to use their previously-approved addendums from either 2016 or 2015. The SBA also modified the standard Addendum Form 2462 to be able to fit with non-franchise concepts by adding language concerning the ability to use licensors and clarifying some issues on restrictive covenants and temporary personnel franchises.
The New Normal
After the initial pushback, the franchise industry has settled into the new normal. Most brands have made determinations on whether they will sign the new addendum, and if so, which addendum they would prefer to use. The first step for a lender when presented with a franchise lending opportunity is to determine whether or not the brand they are dealing with is a franchise according to the FTC’s definition. If it doesn’t, then the brand does not need an addendum based on the way the SOP is written today and there is nothing left to do in regards to affiliation.
If it is a franchise according to the FTC definition, the next step is determining whether the franchisor is going to sign the standard Addendum Form 2462 or if they want to use a previously-approved addendum with SBA Certification Form 2463. Form 2463 is similar to a Certificate of Non-Material Change, and certifies that the language in the current franchise agreement has not changed from the language that the SBA reviewed and amended in the previous documents. If the franchisor would prefer to use a prior addendum from 2016 or 2015, they must also sign SBA Certification Form 2463. If the franchisor is using the 2016 or 2015 addendum, they do not have to use the 2016 or 2015 franchise agreements as long as the franchisor can certify the change provision is true.
After looking at the franchisor’s affiliation preference, the lender must determine the business’ eligibility and take into account any other SBA requirements regarding the franchisor. With this new process, documentation is the key to getting the SBA to fulfill the guaranty.
Future Outlook
Even though the new process has been in place for months now, uncertainty among lenders and those in the industry remain. Where do we do from here? Are there going to be more changes? What is guidance going to be moving forward?
The SBA has said they have been and will remain open to franchisor feedback, and there is optimism in the industry the SBA will adjust their SOP’s if necessary. A specific issue that will need to be addressed is that as the franchise agreements get farther and farther away from the approved documents in 2015 and 2016, fewer and fewer franchisors will be able to sign the SBA Certification Form 2463 and attest there have been no changes, since there are going to be changes over time. What the SBA will do to help these franchisors remains to be seen.
Until then, all we can do is keep following best practices and prepare to be adaptable in the ever-changing franchise landscape.
ABOUT THE AUTHOR
Timothy Seiber is the Franchisor Relations Manager at FranFund, Inc. FranFund specializes in getting franchisees the funding they need to open their business with capitalization solutions based on their individual needs and goals. Previously an associate editor of The Coleman Report, he has intimate knowledge of the franchise and small business lending space. http://www.franfund.com
