Small Business Administration Franchise Loans:

Risk of Loss Can Be Reduced and Program Effectiveness Improved

CED-80-47: Published: Apr 11, 1980. Publicly Released: Oct 27, 1980.

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A review was undertaken of the Small Business Administration's (SBA) franchise loan policies and practices. As of April 1979, SBA had made or guaranteed about 16,400 loans totaling about $1 billion to franchise businesses. However, as of September 1978, the risk of loss by SBA on franchise loans was about $548 million. Moreover, most of SBA franchise business loans have been made under its principal business loan program. The remainder have been made under the SBA Economic Opportunity Loan (EOL) program.

Under the SBA principal business loan program, the 7(a) program, to be eligible for a franchise business loan, a firm must be independently owned and operated and meet the small business size standard that SBA established for the firm's industry. The three types of loans made under the 7(a) program are guaranteed, immediate participation, and direct loans. Guaranteed loans account for about 64 percent of the loans made under the 7(a) program. Furthermore, according to SBA procedures, EOL's are restricted to low-income individuals or persons who, due to social or economic disadvantage, have been denied the opportunity to acquire adequate business financing through normal leading channels on reasonable terms. GAO believes that the SBA franchise guidelines are adequate to ensure loan payment. However, its practices and procedures were not always followed. Moreover, although SBA provides some information, counseling, and management assistance to franchise borrowers, improvement is needed to ensure loan payment. Further, SBA field visits, a necessity in identifying borrower financial difficulties and determining whether management assistance is needed, were not made in accordance with operating procedures for 50 percent of the loans GAO reviewed. SBA officials attributed this to staff shortages.

Recommendations for Executive Action

  1. Status: Closed - Not Implemented

    Comments: SBA disagreed with the requirement of a specific dollar amount for appraisals. An SBA official stated that SBA requires appraisals on a case-by-case basis. The agency does not plan any further action.

    Recommendation: The Administrator, SBA, should require that district offices have independent appraisals made of collateral pledged for those loans exceeding a certain amount, for example, $150,000.

    Agency Affected: Small Business Administration

  2. Status: Closed - Not Implemented

    Comments: P.L. 97-35, enacted August 13, 1981, after the report was issued, requires that loans under $100,000 be guaranteed at 90 percent. SBA officials stated that they have negotiated guarantees of less than 90 percent on larger loans but this is on a case-by-case basis. The agency does not intend to change its policy.

    Recommendation: The Administrator, SBA, should require that district offices, using SBA loan history data, negotiate guarantee rates with banks to reduce the number of loans being guaranteed at the maximum 90 percent rate.

    Agency Affected: Small Business Administration

  3. Status: Closed - Not Implemented

    Comments: SBA disagreed with this recommendation in 1980 and continues to do so. It contends that franchisors, particularly the large and successful, are not in the business of providing financial assistance to franchisees. Therefore, SBA does not intend to act on this recommendation.

    Recommendation: The Administrator, SBA, should require that SBA not make or guarantee franchise loans unless it has evidence that the franchisor cannot guarantee all or part of SBA direct loans or share with SBA guarantees of bank loans made to franchisees. In carrying out this recommendation, SBA may wish to consider limiting franchisor participation to 3 years, the time within which most small businesses that receive SBA-guaranteed loans fail, according to SBA statistics. GAO believes that franchisors would be more receptive to this idea if their participation is limited to a short period rather than the life of the loan.

    Agency Affected: Small Business Administration

  4. Status: Closed - Implemented

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: The Administrator, SBA, should emphasize that the district offices make or otherwise obtain credit analysis of all franchisees, as the Standard Operating Procedures require.

    Agency Affected: Small Business Administration

  5. Status: Closed - Implemented

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: The Administrator, SBA, should require district offices to obtain and review franchise agreements in all cases to ensure that provisions in the agreements do not make prospective franchisees ineligible for loans or unduly restrict their repayment abilities.

    Agency Affected: Small Business Administration

  6. Status: Closed - Not Implemented

    Comments: SBA stated that the bank certified to SBA that it will not make the loan without the guarantee, and SBA agreed. An SBA official also stated that he doubted that the bank would provide SBA with the data the GAO recommended. SBA does not plan any further action on this recommendation.

    Recommendation: The Administrator, SBA, should require district offices to obtain for all loans proof of bank refusal to make loans to franchisees, including the date, amount and terms requested, and the reason for refusal, as required by Federal regulations. Alternative methods of obtaining this information might be to: (1) revise the loan application to include it as part of the required information thereon; or (2) develop a new, short form to be submitted with the loan application.

    Agency Affected: Small Business Administration

  7. Status: Closed - Not Implemented

    Comments: SBA disagreed with this recommendation in 1980 and continues to do so. SBA contends that franchisors, particularly those that are large and successful, are not in the business of providing financial assistance to franchisees. Therefore, SBA does not plan to act on this recommendation.

    Recommendation: The Administrator, SBA, should revise SBA regulations to require that SBA not make or guarantee franchise loans if the franchisor can provide assistance to franchisees on reasonable terms.

    Agency Affected: Small Business Administration

  8. Status: Closed - Not Implemented

    Comments: SBA has made changes in its loan approval procedures to ensure that better quality loans are made. These changes have negated the recommendation and, therefore, the agency does not plan any further action.

    Recommendation: The Administrator, SBA, should require that the headquarters office make financial analyses of franchisors, particularly those whose franchisees have received over 100 loans, and advise the district offices of the results for their use in obtaining franchisor guarantees of SBA direct loans and sharing of bank-loan guarantees with SBA. Also, these analyses will help ensure that loans are not made to franchisees whose franchisors are not financially sound.

    Agency Affected: Small Business Administration

  9. Status: Closed - Not Implemented

    Comments: The agency does not intend to take action because it disagrees with the recommendation.

    Recommendation: The Administrator, SBA, should revise SBA Standard Operating Procedures to define a franchise so that: (1) inconsistencies existing in the district offices in reporting franchise loans will be eliminated; (2) loan officers will not be deprived of information which could result in better loan decisions and reduced risk of loss; and (3) chances of improper review and analysis of loan applications will be reduced.

    Agency Affected: Small Business Administration

  10. Status: Closed - Implemented

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: The Administrator, SBA, should require district offices to limit, to the maximum extent possible, accepting the weaker types of collateral to secure loans, especially inventory and accounts receivable.

    Agency Affected: Small Business Administration

  11. Status: Closed - Not Implemented

    Comments: The agency agrees with the recommendation but does not have nor expects to have the resources to implement it.

    Recommendation: The Administrator, SBA, should establish at the headquarters office an information file on franchise loans, including loan failure rates for each franchisor and the reasons for each failure, to: (1) be disseminated to district offices and prospective franchisee loan applicants for their use in making loan decisions; and (2) help reduce the potential for loan losses.

    Agency Affected: Small Business Administration

 

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