big issues in franchise agreements that prohibits sba … · big issues in franchise agreements...

JW Marriott Washington, DC May 15–17, 2011

Big Issues in Franchise Agreements That Prohibits SBA Lending

Tuesday, May 17, 10:15-11:30 AM State Room JW Marriott, Washington, DC

Moderator: Dennis Wieczorek, Partner, DLA Piper US LLP & IFA General Counsel Panelists: Stephen J. Olear, District Counsel, U.S. Small Business Administration Jane Palsgrove Butler, Executive Vice President, National Association of Government Guaranteed Lenders (NAGGL)


Brief Overview of �SBA’s 7(a) Loan Program


7(a) Program Parameters

•   Maximum loan size = $5 million

•   Maximum SBA guaranty to lender = –   85% for loans of $150,000 and less –   75% for loans over $150,000

•   SBA-charged fees: –  One-time guaranty fee passed on to borrower –

2%-3.75% of guaranteed amount (based on size of loan)

–  Ongoing fee paid by lender – currently .55% per annum


Program Structure

•   SBA does not lend directly •   Small business submits application to lender •   If lender finds loan eligible and creditworthy –   Lender with delegated authority approves loan, gets

loan number from SBA, notifies applicant –   Lender without delegated authority submits loan to SBA

for approval

•   SBA’s approval = guaranty that it will reimburse lender for 75-85% of the lender’s loss on the loan�if borrower defaults

•   Lender funds approved loan


Eligibility Requirements

Applicant must:

•   Not have access to capital from its own resources or credit from other sources

•   Be an operating (not passive) business

•   Be organized for profit

•   Be located in the U.S. with loan funds used in U.S.

•   Be small as defined by SBA

•   Be owned by individuals who are U.S. citizens or legal immigrants, and be of ‘good character’


Size Based on one of two standards – either . . .

•   By industry – measured in terms of either # of employees or gross revenues (established by SBA) – OR

•   NEW Alternative size standard = –  Maximum tangible net worth – $15 million or less, and –   2-year average net income after Federal income �

taxes of $5 million •   Standards apply to applicant and any affiliates

(combined)

•   Determination of franchise eligibility regarded as a sub-set of size determination


Eligible Uses of Loan Proceeds

•   Acquire land and/or purchase, construct or renovate buildings

•   Acquire and install fixed assets

•   Pay franchise fee

•   Purchase inventory

•   Purchase supplies

•   Purchase raw materials

•   Refinance existing debt

•   Acquire existing business

•   Working capital


Credit Analysis

•   Lender uses own process for evaluating credit BUT –  Must analyze each application in a commercially

reasonable manner, consistent with prudent lending standards

•   Applicant’s cash flow considered primary source of repayment – not liquidation of collateral

•   Application must be declined if cash flow inadequate to provide reasonable assurance of timely repayment – regardless of collateral


Lender Will Look at . . .

•   History of business •   Business plan – including need for business in the

area (if new) and competition •   Owners’ and managers’ relevant experience and

personal credit histories •   Applicant’s historical financial statements and tax

returns and projections •   Lender’s credit experience with applicant and

business credit reports •   When franchise, historical success of franchise


Equity Requirements

•   Adequate equity important to long-term survival of business – SBA EXPECTS borrower to make equity injection!

•   Lender must determine if equity and proforma �debt-to-worth are adequate

•   Credit analysis must include discussion of required equity and its adequacy –   Typically lender will require 10-20% (or more!)

injection by borrower


Collateral Requirements

•   Loan must be fully secured to the extent that collateral is available BUT –   Loan will NOT be declined based solely on inadequate

collateral

•   SBA REQUIRES personal guaranty of all owners of 20% or more of business

•   If business collateral (at liquidation value) inadequate to secure loan – lender MUST take lien on available personal assets of principals, including residences


SBA Partner Program – 504 •   Provides long term, fixed rate financing for – –   Real Estate acquisition and/or construction –   Purchase of long-term capital equipment OR –   Limited refinancing

•   Project structure – accommodates larger projects than 7(a) –   SBA share = up to 40% of total project (maximum –

$5.0 million to $5.5 million) –   Private sector lender = minimum of 50% of total project –   Small Business Equity = 10%-20% of total project

•   Most eligibility criteria same as 7(a)


SBA Program Authorities

•   Small Business Act – 15 USC § 631 et seq.

•   Code of Federal Regulations –   Loan program requirements – 13 CFR 120 –   Size regulations – 13 CFR 121

•   Standard Operating Procedures –   SOP 50 10 5(C) – loan processing –   SOP 50 50 – loan servicing (currently being revised) –   SOP 50 51 3 – loan liquidation

•   SBA Notices, Program Guides, forms and other program guidelines

[All available from SBA website – www.sba.gov]


SBA FRANCHISE ELIGIBILITY


Franchise Eligibility/Affiliation

•   ISSUE: Based on the franchise documentation, is Franchisee affiliated with Franchisor and too large under SBA size standards.


AFFILIATION TEST�13 CFR 121.103 (i)

•   Does the agreement provide the franchisee with the right to profit from its efforts and bear the risk of loss commensurate with ownership?


TYPES OF ISSUES THAT CAUSE AFFILIATION

•   A Franchisee does NOT have the right to profit from its efforts, or bear the risk of loss commensurate with ownership when: –  Control Issues –  Transfer Issues –  Other Issues


Control Issues

1. Directly (hire/fire) control the applicant’s employees (unless under a short term step in agreement). a. Allow the hiring of the applicant’s employees by the franchisor (but note the temporary personnel industry).


Control Issues (con’t)

2. Require the applicant to deposit all receipts or revenues into an account which the franchisor controls or from which withdrawals may be made only with franchisor’s consent.



3. Require the billing activities for the applicant to be handled by the franchisor



4. STEP IN RIGHTS –  Franchise Agreements that allow the Franchisor

Step In Rights should contain provisions that allow for review at least every 60-90 days.



5. Purchase Options – •   Options to purchase the applicant’s

personal property upon expiration or breach of the Agreement, is acceptable – however, Options to purchase the applicant’s real estate are NOT acceptable. (This includes option that require a lease of applicants real estate).



•   6. Provisions in the Franchise Agreement that allow the Franchisor to control the price that the Franchise can be sold are unacceptable. –  Provisions that allow for both parties to choose

an appraiser.



7.The provisions of the Agreement may not include a Right of First Refusal on a partial transfer of ownership within a franchise entity.


Transfer Provisions

•   Provisions in a Franchise Agreement that limit the ability of the Franchisee to transfer the Franchise are a problem.

•   Provisions that allow the Franchisor to make a determination for transfer in their “sole discretion” are unacceptable.

•   SBA requires that the agreement contain the following language or its equivalent: –  Consent by Franchisor for transfer will not be

unreasonably withheld or delayed


Liquidated Damages

•   Liquidated Damages clauses should be reasonable. –  Triggered on the breach of the franchisee/

borrower –  Reasonably ascertainable when the agreement

is signed. –  They should not be recorded against the real

estate collateral.


Marketability Issues

•   Deed Restrictions, covenants, easements, reversionary interest and other provisions that restrict the use of the Property for the benefit of the franchisor are NOT acceptable.


Who to Contact with Questions

•   SBA Senior Franchise Counsel, Stephen J. Olear –  [email protected] –   (818) 552 3307


SBA Franchise Registry


What is the Franchise Registry?

•   Partnership between FRANdata & SBA •   Created in 1998 •   An online list of franchise brands to help

facilitate and expedite SBA loan processing. •   Process by which the SBA reviews and pre-

approves franchise agreement, so that lenders can skip this step during the loan process.


Why do this?

•   Credibility •   Some lenders will not proceed with loan if

franchisor is not listed •   Saves time and avoids inconsistent reviews

– do it once for all loans


How it Works

•   Franchisors Apply – go to www.franchiseregistry.com, complete an application, pay fee, submit agreement for review

•   SBA counsel reviews agreements to ensure that the opportunity meets their criteria –  May ask for changes or clarify language

•   FRANdata maintains site, helps complete application, acts as intermediary between you and SBA


Common Issues – Possible to fix

•   Transfers •   Valuation of business (appraiser) •   Operation of the Franchise Business (step-in) •   Security interest on the collateral •   Fees are absent or obscure •   ROFR – not for partial transfers


Common Issues – Problematic

•   Billing & Collection •   Real Estate – no buy-back mandated •   Guarantee Performance of Transferee •   Fees including Royalties too high •   Master, Area Director, Area Rep or

Development Agent (but note area development exception)

•   No unilateral buy-back


Reviews

•   99%+ of Applicants Get Approved –   Most applicants need to make changes to their

agreements (via addendum)


How to proceed

•   Complete the application •   Advise client on how to respond to SBAs

comments •   Advise how client should present inclusion

on the SBA Franchise Registry in Item 10 and on their website


Renewals/Additional Programs

•   Each approval is for the specific agreement –  Separate programs with separate agreements,

require separate review and approval

•   Any changes to agreement need additional review, aka “renewal”


How much and how long?

•   Initial applications $2500; renewal applications $350

•   Initial applications: Currently take 8-10 weeks

•   Renewals: 2-3 weeks •   Depends on any issues with agreement –  And responsiveness in resolving them


Credit Issues

•   Lender may raise one or more issues depending on creditworthiness of borrower –  Term of agreement –  Life insurance –  Access to franchisor records –  Fee deferral –  Notice of termination and lender cure right


Disclosure Issues

•   FDD Item 10 requirements •   Applicable if franchisor has written

arrangement with or receives comp from lender

•   Disclose basic terms •   Note any franchisor obligations (e.g.,

guaranty) •   Attach form agreements •   Any other costs to franchisee

big issues in franchise agreements that prohibits sba … · big issues in franchise agreements...

Documents