California franchisees face 3-in-10 SBA loan failure rate

Nearly three in ten Small Business Administration loans to California franchisees in recent years have failed. That’s according to a new analysis by the Service Employees International Union of over 7,000 loans made to California franchisees over a 20-year period. As the San Jose Mercury News reported, the study shows that franchise owners in California “have a harder time staying current on their loans than in the rest of the nation.”

The failure rate on California SBA franchise loans made between 2006 and 2010 – the most recent period analyzed – is more than double the failure rates in earlier periods. The loans analyzed were made by banks and other private lenders through the SBA’s flagship 7(a) Loan Program.

The failure rate is the percentage of loans to California franchisees that the SBA charged off its books. Such charge offs happen after lenders liquidate all the borrowers’ collateral, which can include their home or other personal assets. Loan failures represent a financial disaster for the borrower, who may have lost both business and personal assets, and a loss for taxpayers, since the SBA has to write off the uncollected value of the loan.

The study of SBA loans to California franchisees follows an earlier SEIU report that found a high and rising risk of SBA loan failure for franchised businesses nationally. The new California study found:

  • One in six SBA loans to California franchisees – 16.5 percent – failed over the 20-year period.
  • Numerous prominent franchise systems that have been significant users of SBA loans in California have high SBA loan failure rates. SBA loans to Domino’s Pizza franchisees in California failed at a nearly 22 percent rate, for example. AAMCO Transmissions franchisees had an over 24 percent SBA failure rate in California, and for franchisees of yogurt chain TCBY it was almost 21 percent.

“The experience of franchise owners across California shows the human side of this data. When a franchise fails, the losses are real. Franchisors implement new and costly rules, and punishments are meted out for the small business owners who can’t comply. I not only lost my business, but my house, my savings, my health, and my marriage,” said Ed Navales, a former franchised small business owner who now runs a successful independent business.

The study shows the need for the kinds of reforms the California Legislature is considering in the Small Business Investment Protection Act (AB 525). The bill, which is set for a hearing June  29, would protect franchisees’ ability to sell their business, which means that .franchisees will have the ability to more easily exit if they are in financial distress. The bill would also prohibit franchisors from terminating franchisees because of minor violations. This means that franchisees will have stability to grow their businesses without fear of arbitrary or unfair terminations by the franchisor.