New Study: One in Six Franchise Loans End in Failure

Service Employees International Union
For Immediate Release: May 14, 2015
Contact: Jack Temple Jack.Temple@berlinrosen.com 734-395-8441
Emma Stieglitz emmaS@berlinrosen.com 646-200-5307
Read the report here

 

New Study: One in Six Franchise Loans End in Failure

Risk growing for franchisees receiving Small Business Administration loans

WASHINGTON, May 14, 2015—A new analysis of Small Business Administration (SBA) lending finds that owners of franchised businesses face a high and rising risk that their investment in the American Dream will end in loan failure. These failures result in the loss of their businesses and potentially the loss of any personal assets pledged as collateral.[i]

The Service Employees International Union’s (SEIU) review of 64,191 loans to franchised businesses through the SBA’s largest loan program reveals that more than one in six franchise loans made over a 20-year period has ended in failure—and that rate has steadily risen.

The failure rate is the proportion of loans that the SBA has written off after all the borrowers’ collateral has been liquidated. Such failed loans also involve the SBA making guarantee payments to the banks or other lenders that made the loans. These failures represent a disaster for franchised small-business owners, who may have lost not only their businesses but also personal assets if pledged as collateral, and a loss for taxpayers.

“The SEIU report on franchisee SBA loans provides powerful evidence of the risks faced by franchisees,” said Tia Orr, senior legislative director of the SEIU California State Council. “We believe the high failure rate is due to a severe imbalance of power between franchisees and franchisors that contributes to a system of too many unstable businesses and low wage work in the franchised fast-food sector.”

The report also shows that:

  • The failure rate – the percentage of all franchise loans that end in total catastrophe for franchisees – has risen in recent years. Almost one in five loans to franchisees – 19.3 percent – have failed in the most recent five-year period analyzed.[ii]
  • More than one in three franchise systems that are significant users of SBA financing have franchisee loan failure rates of at least 20 percent in the most recent period reviewed.[iii]
  • The major brands with loan failure rates of 20 percent or more include not only franchisors whose financial troubles are well known, such as Quiznos and Cold Stone Creamery, but also muffler chain Meineke, printing franchise Minuteman Press and pet store chain Petland.[iv]
  • Individual  franchisees, those whose businesses are neither incorporated nor part of business partnerships, have a consistently higher SBA loan failure rate than franchisees with the protection of a corporation or partnership. In the most recent period analyzed, 21.5 percent of loans to these individual franchisees failed, compared to 19.1 percent of loans to corporate or partnership franchisees.[v]

The report analyzed loan data obtained from the SBA through a Freedom of Information Act request and covered loans made in the period 1991-2010 through the SBA 7(a) Loan Program, the agency’s largest loan program.[vi] Banks and other lenders actually make the 7(a) loans, and the SBA partially guarantees payment.[vii]

The analysis looks at loan performance through October 2014 but does not include loans made after 2010 because, following the methodology of the SBA’s Inspector General, it is too soon to determine whether these more recent loans will fail.[viii]

Franchise boosters assert that “the SBA really likes to back franchisees” and that “buying into a franchise is one of the quickest and easiest ways to jump into the business world – especially for potential entrepreneurs that may not have the skills or creativity to develop their own business concept.”[ix] This study demonstrates, however, that franchising is an increasingly risky form of entrepreneurship that has resulted in losses for taxpayers and for thousands of franchisees

 

[i] Risky Business: Franchisees’ High and Rising Risk of SBA Loan Failure, p. 2.

[ii] Risky Business: Franchisees’ High and Rising Risk of SBA Loan Failure, p. 4.

[iii] Risky Business: Franchisees’ High and Rising Risk of SBA Loan Failure, p. 5.

[iv] Risky Business: Franchisees’ High and Rising Risk of SBA Loan Failure, p. 5.

[v] Risky Business: Franchisees’ High and Rising Risk of SBA Loan Failure, p. 7.

[vi] SBA, “SBA Hits Another Lending Record in FY 2014,” November 6, 2014.  https://www.sba.gov/content/sba-hits-another-lending-record-fy-2014-0

[vii] SBA, 7(a) Loan Programs https://www.sba.gov/category/lender-navigation/sba-loan-programs/7a-loan-programs

[viii] SBA, Office of Inspector General. “The SBA’s Portfolio Risk Management Program Can be Strengthened.” July 2, 2013. p. 13.  https://www.sba.gov/sites/default/files/oig/Audit%20Evaluation%20Report%201317%20The%20SBA’s%20Portfolio%20Risk%20Management%20Program%20Can%20Be%20Strengthened.pdf  

[ix] Joseph Lizio, “Financing Your Franchise Through the SBA,” Franchise Gator, http://www.franchisegator.com/articles/financing-your-franchise-through-the-sba-10609/