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For Some Franchises, SBA Loan Default May be in the Stars

By | 10.07.14

For Some Franchises, SBA Loan Default May be in the Stars

While purchasing a franchise is considered a lucrative and growing industry for many entrepreneurs, research conducted by the Wall Street Journal found a surprising frequency of SBA loan defaults among some high profile companies.

Covering the ten years comprising 2004 to 2013, and centering on those chains with franchisees having 100 or more SBA 7(a) loans, the data revealed that almost twenty percent of these loans were charged off, leaving taxpayers holding the bag – or the bill, if you may.

There were several reasons offered for this trend, including the economic conditions of the period studied, shifting consumer preferences, overhead costs, competition, the restrictions of industry regulation, increased taxes, and poor or questionable marketing and location decisions. However, some of the responsibility falls on the franchise parent company, as several authorities on the industry have pointed to high buy-in and startup fees (which can range from $25,000 to close to $50,000), poor training, lack of parent company support, and large reserve-capital requirements as playing a role.

Compounding the problem may be the fact that franchising chains are not required to publish or provide information regarding failure rates, average first-year sales, and other data that may help in assessing the viability of a franchise investment for those interested in acquiring one.

Among the companies identified in the Journal’s investigation, Planet Beach, Huntington Learning Centers, and Quizno’s had the highest loan default rates. Planet Beach franchises defaulted on over 40 percent of its SBA loans (totaling $11 million), while Quizno’s franchises defaulted on more than $38 million (30 percent). Collectively, more than $120 million in loans were in default. These numbers are not necessarily a reflection on franchisers, though, as the parent companies continue to show profits from franchise sales.

The franchise landscape is not all gloom and doom, however, as several companies are performing quite well. The default rates of Days Inn, Jimmy John’s, and Little Caesar’s pizza, for example, were at or below two percent. In addition, charge off rates have gone into decline over the last few years throughout the industry, with both numbers of loans (8,100) and dollar amounts ($705 million) falling below 2010 levels.

The decline in default is despite the fact that 2013 was the second highest year for SBA approved amounts at $18 billion, perhaps because of a general uptick in the economy and a recognition by parent corporations of the need to provide needed assistance, advice, and training for its franchisees.

Reference:

Needleman, Sarah E. and Coulter Jones. “Franchise Brands with Higher Than Average Default Rates,” The Wall Street Journal. September 10, 2014.

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