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Two Watchdogs Fault SBA for Loose Franchise Loans

Banco Popular
Banco Popular HQ. Photo by miller

The Government Accountability Office and the Small Business Administration's own Office of Inspector General chastised the SBA recently in two separate reports. The beef? Certain lenders were giving out to franchisees a high number of bad loans with high charge-off rates for the SBA. Planet Beach, Petland, and Cold Stone Creamery were cited in the OIG report as franchise systems with particularly high historical default rates. It also cited a report that Banco Popular's loan officers conducted inadequate due diligence in assessing whether Huntington Learning Center franchisee loans could be repaid. Other lending institutions were cited but not named. The GAO focused on an unnamed and now banned loan broker.

Franchise Times' Jonathan Maze reports that the investigations over the SBA not being able to recover its franchise loans seems to be much ado about nothing.

… most doubt the reports will have much of an impact. "Honestly, looking at this stuff, I would have to say no," said John Gordon, a restaurant and franchise consultant out of San Diego.

Reporter Maze estimates that the root of the problem with the high number of bad loans issued by banks and lenders that the SBA and franchisees are struggling with is that franchisees don't do enough due diligence.

…they demonstrate the need for prospective franchisees to do their research before they buy into a system.

U.S. Small Business Administration front in Washington D.C.
SBA Washington office. Photo by dsniegowski

Ah, if only the franchisee newbies would have taken into consideration that they needed a much more deflated first year earnings projection to be realistic. They cannot just use projections that come close to franchise system's average unit volume for all years, if such numbers are available at all while doing due diligence. The GAO — with all its might, investigation of lender, franchisor and franchisee records, and a platoon of investigators — commented on its difficulties of constructing reliable historical financial information for franchised centers. Franchise Times thinks the would-be small business owners should have known to lower first year projections more in their loan application by asking existing franchisees for their numbers.

The GAO report also demonstrated how difficult it could be for those startup franchisees to get good information on how much money their business will make in its first year… The problem? The first-year revenue is usually much lower than revenue for established locations used in earnings claims… Franchisees instead should seek out other sources of information to get that first-year revenue projection, such as existing franchisees. 

Franchise Times concludes that criticism of loose SBA franchise loans is par for the course.

…many of these issues are not new. A previous GAO report said the SBA "accepts greater risks than necessary" in part by not requiring franchisors to share in the guarantee. The date of that report? April 11, 1980.


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