March 18, 2015
Ms. Mary Frias
U.S. Small Business Administration
Office of Financial Assistance
409 Third Street SW., 8th Floor
Washington, DC 20416
Re: Notice/Request for Comments re Franchise Agreement Reviews, Affiliation and Eligibility for Financial Assistance [Docket Number: SBA–2014–0014]
Dear Ms. Frias:
The National Association of Government Guaranteed Lenders (NAGGL) appreciates the opportunity to provide comments to the U.S. Small Business Administration (SBA) regarding appropriate changes to the Agency’s requirements and processes for determining eligibility for participation in the 7(a) program by businesses operating under franchise and other business agreements. NAGGL is a trade association that represents the interests of over 800 institutions that either participate as lenders in SBA’s 7(a) and 504 programs, or provide support services to the lending industry. Our comments reflect the concerns that our members have voiced regarding SBA’s current process for determining franchise eligibility.
NAGGL members have had longstanding issues regarding the factors that SBA considers when determining the eligibility of a franchise or other similar business agreement, as well as the process required for making such eligibility determinations. Specifically, NAGGL believes that the existing requirements and processes are unduly burdensome and confusing and serve as a deterrent to lenders’ ability to provide much needed capital to entrepreneurs looking to start or grow a small businesses within a franchise structure. For that reason, NAGGL applauds the Agency’s commitment to reassessing its franchise eligibility requirements and review process, and looking for ways to better meet the needs of this important business sector.
NAGGL strongly believes that franchise lending is good for America’s economy overall and for its small business sector. Statistics show that franchises support 8.9 million direct jobs and $890 billion of economic output for the U.S. economy. And, according to The Franchise Business Economic Outlook: 2015 prepared for the International Franchise Association (IFA) Educational Foundation by IHS Economics, for the past five years, “[b]y most measures, the franchise sector continues to grow at rates that exceed the economy-wide growth of industries where franchises are concentrated”.
In addition to the significant contributions that franchise businesses make to the U.S. economy overall, the unique business structure under which they operate provides special opportunities for new entrepreneurs, especially those in traditionally underserved markets, to realize their dreams of
starting and growing their own small businesses. To many of these entrepreneurs, SBA-guaranteed loans are a crucial, and, as described by IFA, sometimes the “funding of only resort” available to assist them to open new, or expand existing, franchise businesses. By providing SBA-guaranteed loans to the franchise business sector, SBA helps to fulfill its mission of aiding and assisting small businesses.
However, in its attempt to assure that loans are made only to franchises operating under eligible agreements, SBA has made its eligibility requirements, and the processes by which it determines franchise eligibility more and more difficult and complicated. In addition, in recent years, SBA has expanded the types of agreements that it looks at beyond the franchise and license agreements mentioned in SBA regulations to include dealer, jobber, “similar” and “critical” agreements.
The unintended consequence of the current process is that SBA actually is discouraging lenders from making SBA-backed loans to franchise and other businesses operating under business agreements, thereby preventing capital from being made available to these important small businesses. NAGGL believes that SBA can expand the availability of credit to this sector, without increasing risk to the Agency, by adjusting the standards that it uses, and its processes for determining, franchise eligibility. We hope that our recommendations will be helpful to this process.
SUMMARY OF MAJOR NAGGL RECOMMENDATIONS:
In the attachment to this letter (“Attachment”), NAGGL has included its responses to each question asked by SBA. We believe that our comments and recommendations are in concert with the language and intent of the Small Business Act and the Code of Federal Regulations. NAGGL believes that SBA’s current requirements reflect a very proscriptive approach to implementing the Small Business Act and existing regulations regarding the eligibility of franchise businesses. Our recommendations reflect an appropriate reading of the Small Business Act which we think is fully consistent with the law’s express terms as well as SBA’s mission to facilitate the making of commercial loans on reasonable terms to all small businesses, including those that operate within a franchise structure.
In summary, our major recommendations are that:
1. SBA amend its regulation regarding franchise and license agreements, 13 CFR §121.103(i), to better reflect the intent to make it easier, not harder, to lend to franchise businesses. For example, this regulation could be amended to read as follows:
“Affiliation based on franchise and license agreements. A business concern is not affiliated with a franchisor or licensor by provisions of a franchise or license agreement if the franchisee or licensee remains an independently owned and operated business. In determining whether affiliation exists between the franchisor or licensor and the franchisee or licensee based on the franchisor or license agreement, SBA will rely on a certification from the franchisor or licensor that: 1) The Applicant’s business is or will be independently owned and operated; 2) The Applicant has or will have the right to profit from its efforts and bears the risk of loss commensurate with ownership; 3) The Applicant’s Business and the franchise do not share common ownership or management; and 4) The Agreement does not contain excessive restrictions upon the sale of the franchise interest. Affiliation may arise, however, based on circumstances not related to the franchisor or license agreement as described in 13 CFR §121.103.”
In accordance with the proposed regulation, after obtaining a Franchisor Certification and Addendum (depending on one of two options presented by NAGGL) as specified and described more fully in the Attachment’s Exhibits A and B, the lender’s obligation to determine the business’s independence of operations would be complete. As indicated in the suggested regulatory language, the lender still would be required to determine whether there were other bases for finding affiliation between the loan applicant and a party other than the franchisor. In addition, the lender would remain obligated to determine that the loan is otherwise eligible, including the eligibility of the business’s operational structure, and creditworthiness.
2. The current franchise agreement review process be eliminated, and SBA adopt a process that would allow franchisors, and other entities who enter into similar business relationships with independent small businesses, to self-certify that their agreements will not interfere with the independence of the small business. Use of a self-certification process would be consistent with the way that SBA handles issues of size for purposes of its procurement programs; and more importantly, it would relieve SBA and lenders of the burden of having to examine each agreement for purposes of determining whether it is eligible. This should result in significant savings of manpower and other resources, bolster the Agency’s SBA ONE initiative, and result in more expeditious financing at lower costs to small businesses.
3. SBA reassess its position on which agreements require eligibility determinations and adopt standard definitions to be used by lenders and SBA to determine which contractual relationships require eligibility determinations. We are also recommending that SBA’s loan application form (SBA Form 1919) be amended to clarify to borrowers which business relationship situations require an eligibility determinations.
4. SBA should discontinue the Franchise Registry. If SBA adopts NAGGL’s recommendation and establishes a franchisor self-certification process, the registry will no longer be necessary. However, if SBA decides to continue a review process whereby each agreement will be scrutinized individually, a
registry-like listing of eligible agreements will be required. But, in that case, NAGGL strongly recommends that either SBA maintain the list itself, or that any vendor providing this service be subject to the provisions of the Federal Acquisition Regulations and that the contract include only the custodial and ministerial functions of maintaining and providing access to lenders and potential loan applicants of a list of those franchise agreements that have been found by SBA to be eligible SBA loan purposes. The contractor should not make decisions regarding eligibility, and SBA, not the vendor, should be the entity with whom the franchisors negotiate when issues of eligibility need to be resolved.
NAGGL’s recommendations are discussed more fully in the Attachment which provides the association’s responses to SBA’s questions.
We would like to again thank you for this opportunity to make the views of NAGGL’s members known to SBA on a formal basis, and also would like to offer our help and continuing support as SBA works through this very difficult issue.
Sincerely,
Anthony R. Wilkinson
President and Chief Executive Officer
cc: Ann Marie Mehlum, Associate Administrator, Office of Capital Access
Attachment
NAGGL RESPONSES TO QUESTIONS POSED BY SBA
Background
NAGGL understands that SBA’s requirements regarding the eligibility of franchise businesses for support via SBA loans are rooted in the statutory authority that requires SBA only to provide assistance to “independently owned and operated small businesses that are not dominant in their fields”. However, we believe that the current requirements for determining eligibility and the process for making franchise eligibility decisions are unnecessarily burdensome to SBA, to lenders and to applicants.
With regard to the issue of size for purposes of eligibility for participation in SBA programs, the Small Business Act (§ 3. DEFINITIONS) requires only that a business be one that is “independently owned and operated and which is not dominant in its field of operation”. The statute then charges the SBA administrator to establish “detailed definitions or standards by which a business concern may be determined to be a small business concern” utilizing standards such as “number of employees, dollar volume of business, net worth, net income, a combination thereof, or other appropriate factors”. The statute is silent as to any specific eligibility requirements that must be applied to franchise business operations, other than the mandate that applies to every business, that it be “independently owned and operated and not dominant in its field”.
It is the requirement that a business be independently owned and operated that SBA has determined creates the requirement that it consider the nature of any business agreement between a loan applicant and a franchisor or other contractual partner. So, when promulgating its regulations to implement the statutory mandate that the SBA Administrator define size, SBA determined that, when such agreements exist, they may create affiliation between the two contracting parties such that the business seeking SBA’s assistance may not be considered to be independently owned and operated. When defining various bases on which affiliation can exist, with regard to businesses that have franchise or license agreements, SBA regulations state:
“Affiliation based on franchise and license agreements. The restraints imposed on a franchisee or licensee by its franchise or license agreement relating to standardized quality, advertising, accounting format and other similar provisions, generally will not be considered in determining whether the franchisor or licensor is affiliated with the franchisee or licensee provided the franchisee or licensee has the right to profit from its efforts and bears the risk of loss commensurate with ownership. Affiliation may arise, however, through other means, such as common ownership, common management or excessive restrictions upon the sale of the franchise interest.” [13 CFR §121.103(i) – Emphasis added.]
This regulation reflects SBA’s clear intention that the mere existence of a franchise agreement, in and of itself, would not make a franchise business ineligible for an SBA loan.
This regulation presumes eligibility for a franchise business except when the franchise
agreement inappropriately limits the franchisee’s sale of its business or when the franchisee has other size issues such as those that arise when there are other bases causing findings of affiliation not related to the franchise agreement.
NAGGL RESPONSES TO SBA QUESTIONS:
(1) How can the review of franchise relationships be simplified and still ensure that SBA guaranteed loans are only provided to independent small businesses as required by statute and regulation?
As noted in our background discussion, NAGGL believes that the applicable statute and current regulatory requirements require far less for a determination of franchise eligibility than the exhaustive examination of agreements that the SBA currently requires via the requirements imposed by SOP and the Agency’s actual practice.
In order to simplify and streamline the way that it currently determines whether a business operating under franchise or similar business agreement is eligible for SBA financing, the Agency must address two areas – its requirements for determining that an agreement does not impose restrictions that threaten the independence of a business operating under it, and the process for making such determinations.
RECOMMENDATIONS REGARDING FRANCHISE ELIGIBLITY REQUIREMENTS
NAGGL believes that the simplest and most appropriate means to address franchise eligibility requirements is by amending existing regulations to more clearly indicate that as long as there are no provisions in the franchise agreement that would impede the franchisee’s independence of operations and ability to profit from its endeavors, the franchise agreement should be deemed eligible. We further believe that it is the franchisor who is in the best position to evaluate the intent of any agreement that it creates. Therefore, we recommend that the regulation should provide for a franchisor self-certification process.
To accomplish these objectives, we recommend that that 13 CFR §121.103(i) be amended in a manner similar to this:
“Affiliation based on franchise and license agreements. A business concern is not affiliated with a franchisor or licensor by provisions of a franchise or license agreement if the franchisee or licensee remains an independently owned and operated business. In determining whether affiliation exists between the franchisor or licensor and the franchisee or licensee based on the franchisor or license agreement, SBA will rely on a certification from the franchisor or licensor that: 1) The Applicant’s business is or will be independently owned and operated; 2) The Applicant has or will have the right to profit from its efforts and bears the risk of loss commensurate with ownership; 3) The Applicant’s Business and the franchise do not share common ownership or management; and 4) The Agreement does not contain excessive restrictions upon the sale of the franchise interest. Affiliation may arise, however, based on circumstances not related to the franchisor or license agreement as described in 13 CFR §121.103.”