The Private Equity, Venture Capital, SBA and Non-SBA Lending Hoops & Hurdles

Article by: Lynne D. Shelton

The landscape of financing options and the alternatives to what once was the standard operating procedure is continuing to grow. The Small Business Administration (“SBA”) was for many years the typical way that a franchisee would buy into a franchise system. You would have one owner or maybe a couple of partnership buying the franchise from the franchisor. The Franchisor knew the new franchisees, had many conversations with them, often times even a sit down discover meeting, and then approved of them into the franchise system. Nowadays, financing alternatives have thrown all types of hoops and hurdles into that straight forward franchise entry.

Small Business Administration

The SBA would require the Franchisee to have 20% liquid capital to put down and the SBA loan would take care of the other 80% to get the business opened. However, the SBA’s law changed earlier this year, which had some unexpected ramifications. Some of the changes was doing away with a long held directory named appropriately the SBA Directory or Registry. No longer were franchise systems required to be pre-approved and on the SBA registry. This was always a helpful tool for franchisees and banks alike to be able to look to the registry to see if the SBA had laid eyes on the FDD (Franchise Disclosure Document) previously so they could speed up the lending approval process. Now franchisees and lenders will be left to their own due diligence.
In addition to this the decade long tradition of receiving a SBA required addendum to the franchise agreement called the Form 2468 was purportedly done away with as well. However that seems to not be the case when being underwritten by private banks that processed the SBA loans. In August of 2023 SBA’s new standard operating procedure 50_10_7 still requires the submission of the SBA Form 2468 addendum to the franchise agreement.

Non-SBA Funding Options

Another change in the lending landscape is a decisively higher use of Private Equity and Venture Capital Groups for both funding start-up franchisors and franchisees and purchasing existing multi-unit franchisees and emerging or growing yet established franchisors.

Venture Capital Groups

Venture Capital Groups typically are looking at purchasing new or existing franchise owners. The typical target is an early development franchise system company. However they have also been known to go after multi-unit franchisees that either have a varied portfolio of the types of franchises they own or own 50 franchise units or more.
They commonly have their eyes on a longer asset hold time. Venture Capital Groups are created as a long term investment. They are perfectly happy withholding their investment ownership for more than 510 or even 20 years. They will usually invest with a smaller dollar value ranging only up to a few million dollars.

Private Equity Companies

Private Equity Companies, however, usually start at the investment level of at least a few dozens’ of millions of dollars, up to a few hundreds’ of millions of dollars. They’re usually only interested in receiving a majority interest of the company they are investing in. Oftentimes, the Private Equity Company will retain the management or executive board to run the day-to-day operations, however, even if that becomes the purchased companies reality, they will typically insert a Private Equity executive on the management team as well. That executive will want to give management strategy rules and guidance on mandatory deliverables on how to “turn around the company”. Venture Capital Groups typically will only hold their interest in the company for five years or less before selling off the company to the next highest bidder.

Franchisor’s Hoops

Franchisors that are dealing with buyouts from either Venture Capital Group or Private Equity Groups need to pay particular attention to some hot buttons, not present in a SBA or Liquid Capital sale.
In a typical franchise sale the franchisor would have the owners of the company sign a financial guarantee with the owners of the company. The Federal Trade Commission as well as state regulators and state statutes also have provisions that regulate the transfer of an existing franchisees business. Commonly within the franchise agreement it is spelled out all of the steps that must occur for a franchisee to sell their business and transfer it to a new owner as well as franchisors right of first refusal on obtaining the franchisees business that is up for sale.

In several states it is statutorily mandated under state relationship laws that the franchisees have a right to transfer their business and that franchisors cannot unreasonably withhold such transfers.

If the transfer occurs because the franchisor does not exercise their right of first refusal, there are additional considerations that the franchisor must take into account when dealing with the transfer. Franchisors may need to negotiate provisions with the Venture Capital or Private Equity companies in regards to the approval of the transfer.

The first and foremost would be having a guarantee signed by the new Venture Capital Group or Private Equity Group. Many times it is hard to discern who the actual head of a group is that it has signing authority that could bind the Private Equity Group or Venture Capital Group to a personal guarantee to guarantee the financial requirements as well as the operational requirements of the franchise that is being purchased. If a guarantee is not available, alternative options for the franchisor securing their interest, would be to receive a Letter of Credit on behalf of the new buyer or a Surety Bond that remains in place during the entire term of the Franchise Agreement for so long as Private Equity Group or Venture Capital Group are owners within the franchised business.
If the Private Equity Group or Venture Capital Group are publicly held companies there are other required filing that deal with staying in compliance with the Securities Commission, which will not be discussed in this article, but are daunting to say the least, especially for a newer franchise system.

Whether it is a typical run of the mill franchise sale or a transfer sale that is occurring with the Private Equity Group or Venture Capital Group, Franchisors will have impact that typically will require documentation of some form or another. The biggest key for franchisors would be to have communication with their franchisees so that they can get a true sense of who their new buyers are. It is critical that whenever possible franchisors know who all of the buyers are in the company that owns the franchise unit

Ms. Shelton was the COO of a large franchise system and is currently the Senior Attorney for Shelton Law & Associates franchise law firm, as well as a franchisor owner in an international franchise system, and is currently the CEO of an International Non-profit company specializing in training entrepreneurship to young adults.

Shelton Law & Associates (“SLA”) Attorneys have 50+ years’ business consulting, franchise, and trademark experience. Their knowledge facilitates an understanding of a large variety of businesses, services, site selection, and technologies. They help businesses protect their Brands through Trademark, Copyright, and Business contractual transactions. These services allow SLA to “Expand their Brand®” through Franchising. For Franchisors, SLA provides full outsourced in-house counsel services for a flat monthly fee.

Shelton Law & Associates additionally works with entrepreneurs buying franchises by assisting with Business Creation, Industry Evaluations, Franchise Disclosure Document Review, Fairness Factors, Site Selection, Opinion Letters and Negotiations.

For more information or to schedule a customized consultation for your business, you can write to franchising@SLA.Law or call (866) 99-FRANCHISE.