Franchisees Using ‘Liar SBA Loans’ Blame Lenders

A recent investigation revealed many Small Business Association (SBA) loans granted to franchisees were drafted and paid out based on inflated earnings projections, and a number of those …

A recent investigation revealed many Small Business Association (SBA) loans granted to franchisees were drafted and paid out based on inflated earnings projections, and a number of those franchisees are now pointing the finger at the loan officers who helped them get the loans approved. Industry observers argue franchisees should be held accountable, saying they have an obligation to do their own research and read the contracts they are signing. For their part, many franchisees insist they asked the right questions of loan officers and it was only their lies and misdirection that got them to sign on the dotted line, convincingly arguing that they would not put their homes and assets at risk in a bad business deal had they known the facts. For more on this continue reading the following article from Blue MauMau.

Loan experts say that franchise owners should check for themselves if their loan applications are filled with bogus numbers. Franchisees say easier said than done. SBA liar loans are stacked against them.This is the third of a five part series.

The SBA cited twelve inflated loans among twelve applications from the bank it rebuked, Banco Popular. But there were other banks that weren’t cited in the report. Huntington Learning Center franchisee Sean went through Community West Bank. His projections, prepared by the same lending packager as Randy, used almost identical inflated numbers to those used at Banco Popular. The loan was approved without a hitch. “We were deceived and misled that the actual numbers that we were given by this consultant matched what the franchisor could actually verify as first year franchise averages,” concludes Sean about his experience.

Robert Coleman, small business loan analyst and editor of a newsletter for lenders, the Coleman Report, says, “This is sour grapes. If someone says that the banker or loan broker led me down the primrose trail, I tend to side on behalf of the industry on this one,” says Coleman.

“These people are smart. They know what they are signing,” Coleman stated.

Coleman has a point. In their previous professional lives, some of the franchisees interviewed by Blue MauMau have been bankers, mortgage lenders, private investment bankers and executives of national chains before becoming franchisees and applying for SBA-backed loans.

“They (these small business owners) signed the franchise agreement because they had a dream,” comments lender Arena on why franchisees in general rush into a franchise purchase without taking heed of warning signs. “They want to own a business and they fall in love with the idea. That’s the American dream: to be your own boss,” observes Arena.

Sean thinks that detours around the real issue. “If we would have accurate sales figures for the first year that the centers were open and we knew the true sales average, there would have been less of an inclination to do this business. The business itself wouldn’t have been profitable. We wouldn’t have gone ahead with the loan,” declares Huntington Learning Center franchisee Sean emphatically.

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Coleman thinks that these franchisees need to grow up. “Those are the same people who said that the bank didn’t tell them that they could refinance their house in 2012.” Coleman is referring to mortgage liar loans, home loans with misleading and deceptive documentation that had home owners in homes that they shouldn’t have been qualified to buy. These are popularly referred to as “liar loans.”

“I really would have walked away from the deal,” another franchisee also insists. John feels like the real numbers and the risk were systematically hidden from him, the borrower, who has the most on the line. “Had I known that we were expected to lose six figures for each of the first two years, why would I have put my house, my income, risk being able to put food on the table, and my kids’ education and finances on the line? Any rational person would have walked away.”

Advice: Verify franchise numbers

Lender Arena admonishes future franchisees: “Just do some simple, common sense exercises.” She cites an example where franchisee candidates can stand outside a franchise and count the number of students coming in and out of a learning center and then multiply that by an average purchase to double-check earnings projections.

John did not do that.

When John was first getting involved with due diligence and asking questions about the profits of a learning center, he compiled projections that were lower than what the loan broker provided. The loan broker told him he should raise his projections. He says that the broker easily explained their higher earnings projections that went into the SBA loan application. “I asked Huntington Learning about the lower numbers,” he says. “They told me the reason that I was seeing lower numbers in my research and in the UFOC was because it reflected the business establishments from their old group of teachers who ran centers. They told me that their numbers showed that those of us with a business background were much more successful than the old group of franchisees who were teachers. That sounded reasonable,” says the former franchisee.

Coleman, a publisher of news and information for bankers, points out that the franchisee could have done more. “There is something called the UFOC (the Uniform Franchise Offering Circular, the pre-2008 name for the current Franchise Disclosure Document). Perhaps the franchisee should get on the phone and call some of the existing owners. If you want to buy a Cold Stone, and you read the Wall Street Journal and blogs about all the unhappy franchisees, then who is at fault? Is it the lender, for not reading it? Is it the consultant (i.e. loan broker)? Or is it the borrower for ignoring all of this?”

The message hits home. These entrepreneurs and employers are priests and priestesses for the gospel of taking responsibility for one’s own action. They’ve given the same advice to other borrowers, employees, family, and to themselves. And now they hear the same message that they have preached.

Veteran lender Barbara Arena cautions borrowers that they are ultimately responsible for their loan, no matter whom their consultant is or who gives them bad numbers. “Borrowers should never rely on someone else’s pro forma information. If they don’t have the information to make the pro forma on their own and they cannot substantiate it, they shouldn’t invest in the franchise.” She advises that borrowers must verify all numbers that they receive. “If they can’t do that, they are walking in blindly. They have to look at it from what is in it for the provider of this information. What’s the benefit that they receive? He shouldn’t have bought that franchise. Move on. Don’t buy it if you couldn’t get adequate information by your own due diligence.”

The SBA gives a similar warning to bankers and lenders to be wary of being tricked by bogus financial projections and to know where the numbers come from. In September of 2002, the “SBA’s Experience With Defaulted Franchise Loans” publication cautioned banks: “Franchisors have an incentive to encourage as many prospective entrepreneurs as possible to become franchisees and find financing. Moreover, there is always a risk of some franchisors’ overly optimistic financial projections enabling under qualified prospective franchisees to obtain – and default on – SBA guaranteed loans.”

Bogus future earnings numbers are not just a problem at Huntington Learning Centers. Franchisees of The Coffee Beanery, Cold Stone Creamery and others have spoken with Blue MauMau about franchisors and lending brokers who knew what numbers to put in the loan applications in order to receive SBA guaranteed loans. As the dust settles and they attempt to understand why they could never make money, a few have put together what went wrong with their business investment. A few now realize that the numbers that they were given, after they signed the franchise agreement, were simply made up in order to get money from the government.

Part of this group of franchisees’ rare obsession in playing back the details of the last few years over and over — as opposed to just moving on — has been to figure out what went wrong and to learn from the experience. The more they looked the more there was a gnawing feeling that something wasn’t quite right. After the dust settled, it took John a couple of years to figure out where along the path he had failed in his franchise venture. “I was destined for failure the moment I signed my franchise agreement and obtained the SBA loan from my banker,” John now realizes. “The franchisor, the loan consultant and everyone else knew that these did not generate a profit. The only ones who didn’t know that first year Huntington Learning Centers weren’t profitable was us, the franchisees.”

It’s not just franchisees that have been hurt by bad franchise numbers. Bankers have also been hit hard.

This is the third of a five part series in which Blue MauMau investigates how SBA-backed liar loans have encroached into franchising. It is the result of months of investigation by this journal of SBA-backed loan applications to banks and lenders. Read:

  •  Part 1: SBA Rebukes Banco Popular for Liar Loans
  • Part 2: Franchise Liar Loans Spread among Banks

This article was republished with permission from Blue MauMau.


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