Senators call for more disclosure on SBA franchise loans

Photo by Jon Springer

An effort to require franchisors to provide more information when they receive government-backed loans appears to have gained key support this week.

U.S. Sen. Ben Cardin, D-Md., chairman of the Senate Small Business and Entrepreneurship Committee, backed a pair of proposals from Sen. Catherine Cortez Masto, D-Nev., that would increase the amount of information that franchise brands would disclose whether they receive SBA loans.

One would require the agency to publish franchise brand default rates on SBA loans quarterly. Another would require these brands to provide potential franchisees with more financial information.

Supporters of the legislation say it would give potential operators more information to determine the quality of franchise they want to invest in. “For many small business owners, franchising has been a path to middle class and financial security,” Cardin said in a statement opening a hearing on the SBA’s role in franchising. “For many others, opening a franchise has led to financial ruin. The model carries risks, with a disproportionate amount going to the franchisee.

The proposals have their critics, including the International Franchise Association, which argues the bills attempt to address a need that does not exist and unfairly target franchisors.

“Our view is that requiring a special type of disclosure – for franchisors only – that would add additional data to the (franchise disclosure document) would not be helpful to potential franchisees or would serve a particularly useful purpose,” IFA CEO Matt Haller said in a memorandum statement submitted to Cardin’s committee. He added that the Federal Trade Commission, which regulates franchises, is a better forum for franchise disclosure than the SBA.

The hearing also got bogged down over concerns about inflation and whether the government should support business lending in the first place.

U.S. Senator Rand Paul, a Republican from Kentucky and a ranking minority, complained that the proposed regulations would do nothing to mitigate inflation or balance the budget, cut taxes or repeal legislation. He said the proposals “would weaken a successful business model”.

He then argued, “The best way to avoid risk to taxpayers is to stop putting them on the bill for SBA grants and loans.”

Bryan Tipton, owner of Arby’s franchisee Tipton Investments, argued in testimony at the hearing that if a borrower needs SBA-backed financing, then they’re “probably not doing something good”.

“Taxpayers are taking risky business loans,” he said. “Most of the needs of small business owners can be met in the private loan market.”

The SBA will support lending to small businesses that have difficulty obtaining loans from the private market. The agency supported some $36.8 billion in loans in its 7(a) program and another $7.6 billion in the 504 program, the two most popular such programs.

Many small businesses cannot start without them, including franchises. “The IFA is very supportive of SBA loan programs,” Leanne Strapf, chief operating officer and multi-unit franchise owner of The Cleaning Authority in Columbia, Maryland, on behalf of the association. “These loan programs are essential in helping small businesses get started, giving those who may not have access to capital the opportunity to realize the American dream.”

The Cortez Masto legislation comes in response to a handful of problems in the franchise industry, including Burgerim, which recruited more than 1,500 franchisees in three years, the vast majority of whom were never able to open a store. Most of those who did lost money and many went bankrupt.

The FTC has since sued Burgerim, arguing that the company violated federal disclosure laws by signing up numerous franchisees. The state of California ordered the company to pay a $4 million fine and reimburse franchise fees. The actions followed a 2020 investigation by Restaurant Business into issues within the franchise.

The SBA has backed more than 100 franchise loans, and many argue the agency should repay those loans in light of the FTC and California actions. But many note that the agency should do more to give franchisees information about the investments they are making.

“They absolutely deserve to know what they’re getting into,” Cortez Masto said. “It’s not always the case.”

Robert Emerson, a professor of business law at the University of Florida, said he fears bad franchises will hold back the business model. He doesn’t believe the disclosure proposals would impact franchisor costs because much of this work is already underway. Franchisees, he said, “should have better access to information.”

Yet Aaron Yelowitz, a senior fellow at the Cato Institute, a conservative think tank, argued that there is a “statistically insignificant” difference in chargeback rates for SBA loans made to independent businesses or franchises. And he argued that the best franchisees will choose brands that provide more information.

“Those who provide transparent products will find takers,” he said. “The private market will solve many of these problems.”

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