SBA Franchise Loans: Risk of Loss Can Be Reduced and Program Effectiveness Improved

GAO reviewed 92 loans in 10 of the Small Business Administration's (SBA) field offices. Seventy-eight of the loans were guaranteed and 14 were direct loans, most of which were made to automobile dealers, gasoline stations, and fast food franchises. The SBA risk of loss or share of the outstanding franchise loan balances totaled about $548 million. SBA unnecessarily bore most of the risk on these loans because it did not require franchisors to share in guaranteeing bank loans or to guarantee SBA direct loans made to franchisees. SBA frequently guaranteed bank loans at the maximum allowable limit and made little effort to get banks to take a greater share of the risk. Further, SBA may not be functioning as a lender of last resort as required by law. Its loan files often did not contain adequate documentation that banks and other potential sources of funds had refused to provide financing without SBA assistance. Because SBA did not consider franchisors as a potential source of loans, it may be providing financial assistance to borrowers that could obtain such assistance from non-Federal sources. SBA policy did not require that franchisors be considered as loan guarantors when SBA made direct loans to franchisees. The reason for this was that these companies were not lenders or had no funds to lend. Franchisors would have more incentive to assure the financial success of SBA franchise borrowers if they were required to share the burden of loss with SBA. Generally, SBA procedures of making franchise loans were adequate to ensure reasonable loan repayment. However, SBA did not comply fully with its procedures and Federal regulations which may have contributed to the number of defaulted loans. Franchise agreements are needed to review the contractual terms and financial requirements levied on borrowers. Additionally, SBA does not require marketing studies to determine whether a given area or market will support a business and has not accumulated data on franchise loan failures. GAO believes that SBA should not make or guarantee franchise loans unless it is sure that the franchisor cannot guarantee a, or part of, SBA direct loan or share with SBA in guarantees of bank loans.