New rule changes for SBA lending are effective as of January 1. If you're not familiar with the updates, take this opportunity to learn a little more.
What do the new rules mean? Study up now as everyone on all sides of the transaction will be affected. This includes franchisors, franchisees, restaurant brokers and landlords. What will the changes mean? Will these rules make it tougher to borrow? What about timing? Are we looking at a longer or shorter lending cycle? We may have to experience a few deals to get answers to all these questions but at the outset, it appears the new rules will streamline lending for franchise restaurants.
Here's the short version of the SBA rule changes along with some perspective from the restaurant brokers. The three big changes look relatively simple on the surface but may cause some concern depending on whether you’re a franchisee or franchisor. We attended one webinar where the host stated that “for most brands who have used SBA financing in the past, things will remain relatively the same.” Let’s see if you agree.
What are the big changes?
First and foremost, Franchisors no longer have to submit their franchise agreement for SBA review. This process is sure to shorten the cycle since the franchise review process was relatively cumbersome.
Secondly, franchises will no longer be required to be listed on the Franchise Registry. This is a dramatic departure from business as usual since prior to this, all franchise brands had to have audited financials, submitted to a national clearinghouse and then uploaded to a site accessed by SBA lenders. Removing this step will reduce expense and regulatory burdens on franchisors.
Lastly, under the new rule, both the franchisee and franchisor must sign a two-page addendum to the franchise agreement that covers four provisions: change of ownership; forced sale of assets; covenants; and employment. The SBA lender can NOT make a loan or disburse any loan proceeds unless this addendum is signed. It is an all or nothing scenario so it can’t be negotiated.
What the franchise must understand is that this addendum takes priority over the Franchise Agreement in the event of a conflict. That means that franchisors must now subordinate their interest to the standard agreement.
What are the issues covered by the addendum? It’s basically four areas and this is the specific language of the addendum.
Transfers – SBA Loan New Language
If Franchisee is proposing to transfer a partial interest in Franchisee and Franchisor has an option to purchase or a right of first refusal with respect to that partial interest, Franchisor may exercise such option or right only if the proposed transferee is not a current owner or family member of a current owner of Franchisee. If the Franchisor’s consent is required for any transfer (full or partial), Franchisor will not unreasonably withhold such consent. In the event of an approved transfer of the franchise interest or any portion thereof, the transferor will not be liable for the actions of the transferee franchisee;
The Restaurant Brokers Call Outs on New Transfer Language
On this point, we feel this really helps with individuals who are transferring an interest within a family situation. It’s our position that franchisors should not be collecting a transfer fee or using a family change to force someone out. We are big fans that for the new language that franchisors shall not unreasonably withhold consent. This is new language and we feel this is advantage – franchisee!
Option to Buy – SBA Loan New Language
If Franchisor has the option to purchase the business personal assets upon default or termination of the Franchise Agreement and the parties are unable to agree on the value of the assets, the value will be determined by an appraiser chosen by both parties. If the Franchisee owns the real estate where the franchise location is operating, Franchisee will not be required to sell the real estate upon default or termination, but Franchisee may be required to lease the real estate for the remainder of the franchise term (excluding additional renewals) for fair market value;
The Restaurant Brokers Call Outs on this new provision - Option to Buy
This is interesting language from our viewpoint. The point that a Franchisee will be required to be the landlord for the franchise brand (even if they are no longer under a franchise agreement) introduces a new dynamic to the process. Imagine that you own your real estate and open a Dunkin Donuts franchise. At some point, you decide (or they decide) to terminate the relationship. Under this constraint, you may be required to lease the real estate so it can remain a Dunkin Donuts even if you are no longer the franchisee at “fair market value.”
The restaurant brokers see a lot of ways this could go sideways if a franchise is terminated. It might be a smart idea (if you own the property) to consider selling this to a non-related group over which you have control (and doing a lease back) before entering into amendment. In our mind, this is advantage – franchisor!
Real Estate Control – SBA Loan New Language
If the Franchisee owns the real estate where the franchise location is operating, Franchisor may not record against the real estate any restrictions on the use of the property, including any restrictive covenants, branding covenants or environmental use restrictions; and
The Restaurant Brokers Call Outs on this provision - Real Estate Control
It has been a relatively common industry practice for a build to suit scenario where the franchisee owns the real estate for the franchisor to place restrictive covenants and/or branding covenants restrictions. This language appears to remove their ability to do so by not allowing restrictive covenants or branding covenants. We see this one as advantage – franchisee!
Franchisor will not directly control (hire, fire or schedule) Franchisee’s employees.
The Restaurant Brokers Call Outs on this provision - Employees
This is a win for franchisors who rightly, should not have their franchisees considered as employees. There has been an unheard of amount of language written on this topic in 2015 as the Obama administration worked to bring into play ‘joint work” scenarios whereby franchisees were viewed as employees. This one is advantage – and rightly so – Franchisor.
This is our initial reading of the new rules and provisions in the amendment. As we see these play out in actual restaurant lending situations over the coming year, the restaurant brokers will continue to weigh in with updates.
Want to see our restaurant for sale listings already approved for SBA Lending? Check them out at this link.