Franchise Sales: What You Should Know About SBA 7(A) Loans and How They Structure Their Franchise Agreements | Internicola Law Firm

What Franchisors Should Know About SBA 7(A) Loans

Franchise Sales: What Franchisors Should Know About SBA 7(A) Loans and How They Structure Their Franchise Agreements?

SBA 7(A) Loans

The Small Business Administration’s “7(a)” loan program serves as a reliable and effective source of financing for new franchisees. The SBA 7(a) Loan program is the primary loan program offered by the SBA for franchisees who are purchasing a franchise and establishing their franchised operations. Under this program, the SBA does not issue any loan but, rather, encourages SBA qualified banks to loan funds to qualified start-up business owners and, in turn, the SBA will guarantee to the bank repayment of a significant portion (up to 85%) of the loan.

The value of SBA 7(a) Loans are readily apparent to franchisors as these loans may serve as a solid source of financing for new franchisees. Naturally, SBA 7(a) loans involve a more stringent review and qualification process. This review and qualification process not only applies to “borrower franchisees” but also to the franchisor and, in particular, the nature of the franchise relationship and the terms of the relevant franchise agreement. So, when preparing, developing and updating your FDD and franchise agreement, as a franchisor, you must be aware of SBA franchise agreement qualification requirements. Some of the many SBA underwriting loan requirements and/or regulations that may impact your franchise agreement include:

Franchise Agreement Red Flags

Transfer Restrictions

The SBA recognizes that franchisors possess a legitimate concern as to franchise transfers and that franchisors must maintain a right to review and approve the transfer of a franchised business. However, for the SBA – the entity that will be determining whether or not to approve a loan to your franchisee – a franchisor’s right to approve transfers cannot be absolute or unrestricted. That is, the franchise agreement must include some language and right whereby the franchisor acknowledges that the franchisor’s review and approval of a franchise transfer shall “not be unreasonably withheld or delayed”.

Liquidated Damages

Liquidated damage provisions in franchise agreements, typically, relate to an agreed upon formula or monetary amount that franchisor and franchisee agree to (at the time of signing the franchise agreement) for the purpose of determining the amount of damages the franchisor may be entitled to in the event that the franchisee breaches the franchise agreement. Naturally, if a franchise agreement default occurs, the SBA wants to ensure that potential repayment of the SBA guaranteed loan is not jeopardized by an excessive award of damages to be paid by franchisee to franchisor. Accordingly, the SBA scrutinizes franchise agreement liquidated damages provisions and requires that these provisions be “reasonable.” These provisions should only be triggered after a breach of the franchise agreement and, at the time of signing the franchise agreement, the nature and potential amount of the liquidated damages must be reasonably ascertainable.

For franchisors, the SBA conducts a pre-approval process wherein the SBA will review and evaluate your franchise agreement and your franchise offering. If approved, your franchise will be added to a registry of SBA approved franchisors. This approval does not guarantee that the SBA will approve loans to your franchisees but, rather, will serve to expedite the review process should a franchisee apply for an SBA loan. Start-up franchisors should consider this review process as a good test of their franchise agreement and a great opportunity to identify potential problems and recommended franchise agreement modifications.

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