The overall message we received was that franchise lenders have robust volume and are looking for more deals. Below are four key questions and answers from the lender’s conference with over 450 of the most active lenders will help you understand how lenders are thinking.
Q: How loose are SBA lender’s credit boxes?
A: Deferments in the SBA Portfolio have DOUBLED since last year.
This is a sign of small business stress and will shape the lender’s risk assessment on a go-forward basis.
Lenders are trying to be flexible with their borrowers. A joke was made that lenders “Extend and Pretend.” Lender push out the payments and hope for the best. But in reality, a lender is trying to determine – can the borrower recover? When that deferment period is over are they going back to principal and interest, or will the lender extend the maturity, or tack on additional payments? Lenders have to also make sure that during the deferment period, the collateral doesn’t grow legs, or the valuation of the business doesn’t dramatically change which affect a lender’s recovery. What can you do as a franchisor to help the lender bring relief to your franchisees and provide a plan that the deferment period will lead to a better business that can repay.
Q: What is the evolving response of lenders who are now left with shouldering the responsibility of assessing and verifying franchise eligibility?
In a peer to peer lender session, there was unanimous consensus by lenders grumbling about the uncertainty of how to handle franchise eligibility now that SBA is no longer vetting franchises. A lender stood up and said FRANdata has the solution with a Certification of Franchise Documents. Another lender whose bank requires the certification, validated that it’s a required CYA document for their bank. Paul Santomauro, Director of Lending and Credit Risk products explained the certification and how it took months to create and covers 26 years’ worth of eligibility decisions. There was a sigh of relief and a rush of lenders to FRANdata to learn more. More and more lenders are coming to the Franchise Registry to access the certification as part of their underwriting process.
Q: What does SBA mean when they say the newest issue in franchising is FRAUD?! (Warning to those advertising as passive businesses)
A: Franchise, Franchise and More Franchises… was the bullet point on SBA’s slide during a lending session. What followed was unsettling. SBA scared lenders by saying that the newest issue in franchises is FRAUD and called some franchises Ponzi Schemes. This is enough to stop any lender in their tracks. There are “franchises” they say who are passive businesses, selling equipment that isn’t being put in the business and lenders must BEWARE. Needless to say we were appalled at this misguided sentiment.
Thankfully, we at FRANdata were there to understand the real issue behind those words and were able to separate the fear mongering from truth. It’s not about being a franchise — no royalties, no initial franchise fee, no marketing fee, and no territory restrictions. The issue really is when a business is a passive business. SBA is instructing lenders to drill down on management agreements and be aware that passive Businesses are not eligible businesses for SBA loans and they will be denied their guarantee.
Follow up question: Are you advertising your franchise opportunity as a Passive Business? Or do you have a management agreement to run the franchisee’s business?
If so, it may spook a lender now. Make sure that your franchisee can prove that they will be doing the items listed below:
- “Meaningful oversight” by the franchisee means involvement in the decisions made concerning the operation of the business, which include a management agreement that provides for the franchisee to do all of the following:
- Approve the annual operating budget;
- Approve any capital expenditures or operating expenses over a significant dollar threshold;
- Have control over the bank accounts; and
- Have oversight over the employees operating the business (who must be employees of the franchisee business).
Q: Franchisors have frequently asked, why don’t lenders make a single disbursement of funds especially if it’s a service business without any construction.
A: Lenders have to document and VERIFY the use of proceeds (funds). If they make a single disbursement, the borrower could just apply those funds to the nice Porsche he/she always wanted and not to the business. In that case, the SBA lender would not get it’s guarantee if the loan went bad.