Streamlining the SBA Approval Process with a Universal Addendum

Streamlining the SBA Approval Process with a Universal Addendum

Over the past year, many of our franchisor clients have raised concerns about the length of time that it takes for their FDD and Franchise Agreement to be approved by the Small Business Administration (SBA), which is a requirement to listing a franchisor on the SBA Franchise Registry.  Being listed on the Registry greatly facilitates the approval process for franchisees that seek SBA financing because the franchise agreement doesn’t need to be reviewed for each individual franchise sale.  In essence, the SBA is pre-approvinga franchisor’s FDD and Franchise Agreement for financing.

After reviewing the franchise agreement, the SBA has generally required franchisors to agree to an addendum that amends certain provisions in the franchise agreement so that they comport with SBA requirements. While the SBA prepares a draft addendum, many of our clients have elected to have us review and negotiate with the SBA so that they can modify the draft form of addendum to better align with the requirements of a particular franchise system or industry.

In 2016, the negotiation of specific addenda, as well as other resources constraints, led to longer response times from the SBA, with some franchisors waiting several months before their 2016 FDD was approved and listed on the Registry.  In order to address concerns regarding these delays and to otherwise streamline the approval process, the SBA recently released a new standard operating procedure (SOP), under which the SBA will publish a universal addendum and present it to franchisors on a take-it-or-leave-it basis.  This shift, which will become effective on January 1, 2017, presents a double-edged sword to franchisors, because it will greatly reduce the approval timeframe, but it will also remove a franchisor’s ability to negotiate a specific form of addendum that is tailored to the unique characteristics of its system.  If the universal addendum is unworkable for a particular franchisor, then they are out of luck – if the franchisor doesn’t agree to use this addendum, their franchisees won’t have access to guaranteed SBA financing.

The SBA recently released the form of universal addendum that it will use for 2017, and it contains the following requirements:

(1) restrictions on a franchisor’s right to purchase a partial ownership interest in a franchise by exercising its right of first refusal, along with the long-standing SBA requirement that franchisors cannot unreasonably withhold their consent to any transfer;

(2) procedures for calculating the value of the franchisee’s personal property upon termination (with respect to repurchase by the franchisor), with additional restrictions regarding situations where the franchisee owns the real estate associated with the franchised business;

(3) a prohibition against a franchisor recording any restrictions on the use of any property if the real estate is owned by the franchisee; and

(4) a prohibition against a franchisor directly controlling (e.g., hiring, firing, or scheduling) a franchisee’s employees.

While it is possible that these provisions present challenges for certain franchise systems, they are phrased in a general manner so as to be workable for the majority of franchisors, and we believe that they are both reasonable and in line with the SBA’s most common requirements from prior years.  However, what remains to be seen is how the SBA will handle franchisors with a legitimate business reason as to why they cannot incorporate one or more of the provisions of the universal addendum.  Setting this aside, and assuming this development will greatly reduce the approval time frame, we believe that on a whole this change will be beneficial to franchisors and franchisees alike.