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WHEN SIZE MATTERS: THE U.S. SMALL BUSINESS ADMINISTRATION’S AFFILIATION ASSESSMENT FOR FRANCHISING

Nearly a third of respondents to SBA notice endorse IFA’s position in whole or in part.

By Elizabeth Taylor and Rolf Lundberg

 

A delegation of franchisees and franchisors representing the more than 26,000 franchise establishments throughout North Carolina met with legislators in Raleigh on April 14 to promote the franchise model’s contribution to the state and educate lawmakers about policies that will help these businesses continue to grow and create jobs.

In December 2014, the U.S. Small Business Administration published a notice in the Federal Register requesting comments regarding the important question of “affiliation” between a franchisor and its franchisees.

If SBA makes an erroneous determination of what constitutes affiliation between a franchisor and franchisee, it could result in broad denials of loan guarantees and cause serious harm to franchising.

IFA and others responded with comments that provide guidance for SBA and will help the agency maintain and increase the availability of loan guarantees for franchise businesses.

The U.S. Small Business Administration plays an important role in helping franchise businesses gain access to capital. Through SBA’s 7(a) and 504 loan programs, in 2014 alone SBA guaranteed the financing of nearly 30,000 new franchised units, resulting in an estimated $6 billion in loans to new and prospective franchisees. According to a survey conducted for IFA by FRANdata, in 2014 an estimated 43 percent of first-time franchisees and an estimated 23 percent of franchisees acquiring additional franchises, used SBA loan program guarantees. The SBA’s loan programs provide significant and crucial capital to franchise businesses.

As the representative of all stakeholders in the franchising community and given its long history of working with the SBA to ensure financing flows to franchise businesses, IFA was pleased to provide insight on the guidance necessary to help franchisors and franchisees avoid SBA-defined affiliation issues, which negatively affect qualifying franchisees’ access to SBA-guaranteed loans.

In its notice, the SBA laid out three categories of issues. The SBA first described five examples of “common affiliation issues found in franchise agreements.” It then raised three “new issues,” which it said may indicate affiliation or excessive control. Finally, the SBA asked thirteen questions that the agency said “could require new statutory or regulatory authority.”

As a preliminary matter, IFA emphatically stated in its response it in no way concedes, and “adamantly” opposes, the SBA’s underlying approach that franchisors and franchisees may be “affiliated” under any definition of the term. IFA reiterated throughout its comments that it is indisputable that franchisees are independently-owned and operated small businesses.

That said, IFA recognized that if franchisees’ businesses are incorrectly determined to be affiliated with a franchisor’s business under SBA regulations (regardless of the underlying rationale), then they will forgo access to much-needed capital because they will be ineligible for SBA loans due to its congressional mandate to only lend to small businesses.

IFA’s full comments were extensive and cannot be sufficiently summarized here, but some brief highlights follow. The comments included a discussion of the proper treatment of receipts deposited into a franchisor-controlled account and when franchisor billing of customers is necessary, the appropriate restrictions a franchisor may place on a franchisee’s transfer of the business interest, a franchisor’s ability to set a price on the sale of assets upon termination, expiration, or non-renewal of the contract, and reasonable restrictions on the franchisor’s step-in rights.

IFA’s comments further recommended modifications to the loan application process to simplify and streamline it. These suggestions include conducting franchise affiliation reviews based on a set of published standards that are fixed for at least two years at a time and allowing franchisors to sign a non-material change statement each successive year after an SBA review in lieu of another costly and time-consuming SBA review. IFA also urged greater distribution of any proposed changes to the affiliation standard by the SBA to the franchising community, such as through the IFA and the American Bar Association Forum on Franchising.

The full details of the SBA’s request for comments and IFA’s response may be found in the federal register at www.regulations.gov, docket number SBA-2014-0014. In all, the SBA received 117 comments in response to the notice, and more than 40 of these comments explicitly endorsed the IFA’s position in whole or in part.

IFA will continue to work with the SBA to help America’s small businesses access much needed capital to ensure they continue to flourish without impediments.

Elizabeth Taylor is vice president of federal government relations, public policy and counsel at the International Franchise Association, and Rolf Lundberg is principal at The Lundberg Group, LLC. Find them at fransocial.franchise.org

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