Client Alert: SBA Issues New Procedures Aimed at Simplifying Franchise Financing

On October 13, 2017, the U.S. Small Business Administration (SBA) announced significant changes to its procedures for processing franchisor financing. In particular, the SBA issued “Standard Operating Procedure (SOP) 50 10 5(J),” which revises the SBA’s franchise review procedures for 7(a) and 504 loans. These new changes roll back some of the procedures put into effect in late 2016 and early 2017 with the goal of improving consistency for lenders and ultimately making it easier for franchisees to obtain financing.

To help you better understand the SBA’s new procedures, we have summarized the key SOP revisions impacting franchisors and have created a list of initial action items designed to help you ensure that your brands are in compliance.

It is also important to note that the newly issued SOP does not take effect until January 1, 2018. For loans processed before then, SBA lenders must continue to follow the SBA’s current policies and procedures that are set out in SOP 50 10 5 (I) and SBA Policy Notice 5000-1941.

If you have questions about complying with the SBA’s new or existing policies and procedures, please reach out to one of Plave Koch PLC’s franchise professionals.

Summary of Key Revisions under SOP 50 10 5(J)

For franchisors, the key revisions in the new SOP are: (1) the creation of the SBA Franchise Directory; and (2) a new annual certification requirement for some franchisors.

(1)            The SBA Franchise Directory

The SBA has created the SBA Franchise Directory (the “Directory”), which provides a centralized list of every franchise brand that the SBA has reviewed and deemed eligible for SBA financial assistance. Starting January 1, 2018, any brand that meets the FTC’s definition of a “franchise” must be listed on the Directory to obtain SBA-backed financing. If a franchisor’s brand is listed on the Directory, lenders and Certified Development Companies (CDCs) may process the loan application without reviewing a franchisor’s documentation for affiliation and eligibility.

The Directory contains the following information for each franchise brand:

  • Whether the brand meets the FTC definition for a franchise;
  • The “SBA Franchise Identifier Code” for the brand;
  • Whether the brand is required to use an addendum, and if so, whether the brand will be using the SBA’s standard addendum (SBA Form 2462) or a negotiated addendum; and
  • Whether there are any additional issues the lender must consider with respect to the franchise brand.

Franchisors may find that their brand(s) are already included on the Directory, as the SBA has begun populating the Directory with the details of brands that it had in the past deemed eligible for SBA-backed financing. Thus, franchisors should review the Directory to see if their brand(s) are already listed, and if so, whether the information provided in the Directory is up to date.

If a franchisor’s brand is not currently listed on the Directory, the SBA has created a simple process for adding brands. To add a new brand to the Directory, the franchisor must submit its franchise agreement, Franchise Disclosure Document (if applicable), and any other documents that the franchisor requires its franchisees to sign to franchise@sba.gov for an eligibility and affiliation determination. There is no filing fee or standardized filing form and the franchisor does not need to provide any sort of memorandum to the SBA that states why the brand should be added to the Directory. The process for requesting updates to information already listed on the Directory is the same as the process for adding a new brand.

The SBA’s criteria for determining whether a franchisor’s business model is eligible for SBA-backed financing has not changed. When determining whether a franchisor is eligible to be listed on the Directory, the SBA will look at whether a business operated under the franchisor’s business model:

  • Will be an operating business (except for loans to Eligible Passive Companies);
  • Will be organized for profit;
  • Will be located in the United States;
  • Will be able to meet the SBA’s “size” requirements; and
  • Will be able to demonstrate a need for the desired credit.

In certain situations, the SBA may request additional information from the franchisor (such as the franchisor’s operations manual) to complete its eligibility review.

If the SBA determines that the franchisor’s documents create an “affiliation” relationship between the franchisor and the franchisee, then, as in the past, the franchisor will be required to use an addendum to their franchise agreement. Franchisors will have the option to use either: (a) the SBA’s standard addendum (SBA Form 2642); or (b) a negotiated addendum that amends the provisions that create the “affiliation.”

The SBA creates a clear incentive for franchisors to use the standard addendum, as franchisors who agree to use the standard addendum will be presumed to meet the SBA’s affiliation requirements. If a franchisor wishes to use a negotiated addendum, that addendum must be reviewed and approved by the SBA (and, as in the past, the SBA may comment upon and require changes to any proposed negotiated addendum).

(2)            Annual Certification Requirement

For franchisors that use the SBA’s standard addendum, there will continue to be no annual certification requirement to remain on the Directory. Thus, the SBA again offers franchisors a powerful incentive to use the SBA’s standard addendum.

Franchisors that don’t use the SBA standard addendum, however, must meet a new annual certification requirement if they: (a) are not required to use any addendum to their franchise agreement; or (b) are using a negotiated addendum. For franchisors that fall into one of those groups, the franchisor must annually certify to the SBA that:

  • If the franchisor is not using an addendum, the terms of the franchisor’s current agreements that affect “affiliation” have not changed since the SBA last conducted their review for the franchisor’s placement on the Directory; or
  • If the franchisor is using a negotiated addendum, the franchisor has not made any changes to the addendum.

A franchisor’s annual certification must be submitted to the SBA as soon as it issues an updated franchise agreement, but in no event later than April 30 of each calendar year. The certification must be made using the SBA’s form of “Annual Franchisor Certification” (SBA Form 2464).  There is no filing fee related to the annual certification.

Franchisors who have had their brands pre-populated on the Directory must provide an annual certification for those brands by April 30, 2018 if they are not currently using the SBA’s standard addendum.

Franchisors that fail to file their annual certification in time will be required to use the SBA’s standard addendum until the SBA has a chance to re-review that franchisor’s documentation. Similarly, if a franchisor is using a negotiated form of addendum, and it wishes to revise that addendum, the franchisor will need to follow the process set forth in the SOP for adding new brands to the Directory.

Initial Action Items for Franchisors

Many franchisors, specifically those currently using the SBA’s standard addendum, will find that they are already in compliance with the SBA’s new procedures. Still, with the effective date of the new SOP fast approaching, franchisors are wise to take the following steps now to ensure compliance and avoid unnecessary delays:

  1. Review the SBA Franchise Directory: Franchisors should review the Directory to determine whether their brands have been pre-populated by the SBA, and if they have, whether the information on the Directory is accurate.

a. If your brand information is pre-populated to the Directory and accurate: For franchisor’s currently using the SBA’s standard addendum, no further action is necessary. Franchisors that are either not required to use an addendum or are using a negotiated addendum may continue to take advantage of SBA-backed financing for their brands, but will need to prepare and submit an Annual Franchisor Certification by April 30, 2018.

b. If your brand information was not pre-populated to the Directory or needs to be updated: Franchisors who would like to add their brand to the Directory or update inaccurate information must submit their franchise agreement, Franchise Disclosure Document (if applicable), and any other documents that the franchisor requires its franchisees to sign to franchise@sba.gov for an eligibility and affiliation determination. Depending on the brand, the SBA may request additional information, such as the brand’s operations manual.

  1. Prepare an Annual Certification Requirement (if applicable): Franchisors who have been pre-populated on the Directory must prepare an Annual Franchisor Certification by April 30, 2018 if they are not currently using the SBA’s standard addendum. The Annual Franchisor Certification must be submitted to the SBA in accordance with the instructions listed in SBA Form 2464.