The U.S. Small Business Administration (SBA) reinstated its Franchise Directory earlier this year. Its decision to discontinue the Franchise Directory in 2023 as part of a broader effort to streamline its lending programs was largely decried within the franchise industry, with the International Franchise Association (IFA) noting at the time that about 20 percent of all SBA loans go to franchisees, and that franchising had played a significant role in the United States’ post-pandemic economic recovery. Now that the SBA Franchise Directory is back, what do you need to know? National franchise attorney Jeffrey M. Goldstein explains.
Why the SBA Franchise Directory is Important for Franchisees
The SBA Franchise Directory is a list of franchisors that meet the SBA’s eligibility requirements for loan guarantees. By guaranteeing loans, the SBA provides certainty to private lenders, and, in turn, these lenders are more willing to extend financing to franchisees.
When the SBA eliminated its Franchise Directory in 2023, the goal was to streamline the SBA lending process by allowing banks to make eligibility determinations based on a set of flexible standards for approval. In practice, however, this approach not only slowed down the process but also led to increased costs and an increased denial rate for prospective franchisees.
As a result, for prospective franchisees who need (or want) to obtain SBA-backed loans, the return of the SBA Franchise Directory is a positive development. As the SBA explains:
“The SBA Franchise Directory contains all franchises and other brands eligible for SBA financial assistance. It only includes business models that are reviewed and found eligible by SBA. Lenders will be able to rely on the Directory and will no longer need to review franchise or other brand documentation for affiliation or eligibility.”
Prospective franchisees can check the directory to see if their chosen franchisor is listed, and if it is, they can then use this to help facilitate the financing process.
Inclusion in the SBA Franchise Directory Does Not Indicate Endorsement or Approval
While choosing a franchisor that is listed in the SBA Franchise Directly can help prospective franchisees obtain financing, a franchisor’s inclusion in the directory is not an indication that the franchisor itself is “approved” or otherwise endorsed by the SBA. Rather, inclusion in the directory simply means that the franchisor has met the SBA’s eligibility standards—which are largely based on compliance with the Federal Trade Commission’s (FTC) Franchise Rule.
Thus, when buying a franchise from a franchisor that is listed on the SBA Franchise Directory, prospective franchisees still need to perform all necessary due diligence. Among other things, this includes:
- Carefully reading the Franchise Disclosure Document (FDD) and franchise agreement
- Attending a “discovery day” at the franchisor’s headquarters
- Talking to several current and former franchisees in the system
- Developing a business plan pro forma
- Hiring a franchise attorney to conduct a franchise business review
If a franchisor is listed on the SBA Franchise Directory, prospective franchisees should only consider this as a factor when assessing their options for financing. Prospective franchisees should not consider this as a sign that the franchise opportunity is viable. For franchisors, getting on the SBA Franchise Registry is not particularly difficult, and many franchisors use this as a marketing tool—because they know that many first-time franchise buyers will be looking specifically for franchise opportunities that provide access to SBA-backed financing.
What Factors Should You Consider When Choosing a Franchise?
With this in mind, if you are thinking about buying a franchise and are looking specifically at opportunities that are eligible for SBA loans, what factors should you consider when deciding which opportunity to pursue? Here are just some of the factors you will want to consider before you commit to moving forward:
- The Franchisor’s Financial Status – A franchisor’s financial status can play a major role in the viability of its franchise offering.
- The Franchisor’s Leadership Team – Are the franchisor’s executives experienced in the business? Do they also have experience in franchising?
- The Size and Status of the Franchise System – Is the system growing? Is it growing in your area? Are franchisees leaving the system?
- The Franchisor’s Financial Terms – Your franchisor’s initial franchise fee, royalty rate and mandatory marketing fund contribution can all have a major impact on your profitability.
- Mandatory Purchases and Designated Suppliers – Mandatory purchases and designated suppliers can add to the cost of operating your franchise.
- Initial Term and Renewal Rights – Is the initial term long enough to recoup your initial investment? Do you have sufficient control over your ability to renew?
- Territory Rights – If you will receive territory rights, will your territory be truly exclusive, or will it have more limited protections?
- Default, Cure and Termination – What constitutes a default under the franchise agreement that justifies early termination? What right do you have to cure prior to termination?
- Post–Termination Liability – If you lose your franchise, will you be liable for “lost future royalties” or other liquidated damages as a result of early termination?
- Enforcement and Dispute Resolution – If you only have limited options for enforcing your legal rights, this could limit the viability of holding your franchisor accountable when necessary.
Again, these are just examples. From choosing your financing source to deciding what risks you are willing to accept, there are numerous important considerations involved in buying any franchise. The key is to ensure that you are making informed decisions throughout the buying process. While there are no guarantees, this will help ensure that you do not encounter unwanted surprises, and it will help maximize your chances of long-term success.
Are You Thinking About Buying a Franchise? Schedule a Free Consultation with National Franchise Attorney Jeffrey M. Goldstein
Are you thinking about buying a franchise? If so, we invite you to contact us to learn more about the steps involved in making an informed buying decision. To schedule a free consultation with national franchise attorney Jeffrey M. Goldstein, give us a call at 202-293-3947 or tell us how we can help online today.
