Puerto Rico-based bank Banco Popular was recently admonished for its approval of Small Business Association (SBA) loans to companies that it did not properly analyze for earnings and repayment potential. Now it appears the practice of issuing “liar loans” is not limited to Banco Popular, with industry insiders coming forth with claims that loan officers never look at earnings projections; that those concerns are so far down the list as to be unacknowledged. Further investigation has revealed that banks are only half the problem, and that many franchisors have provided false earnings statements to franchisees seeking loans, often inflating projected earnings on paper to ensure the franchisee accepts the risk and also gets the needed SBA loan. For more on this continue reading the following article from Blue MauMau.
A major franchise lender, Banco Popular, has been rebuked by the Small Business Administration for participating in lending chicanery. The censure has both the lending and franchise industries concerned that the investigation may spread beyond the Puerto Rico-based bank.
Experts think that the real reason Banco Popular was singled out was that its vice president admitted to the SBA that the bank had not bothered to verify earnings projections from franchise borrowers. Although the SBA’s Office of Inspector General (OIG) focused on 12 loans that the bank provided to Huntington Learning franchise owners, it looks like the number of loan applications with bogus earnings projections extend far beyond the confines of the bank, and far beyond Huntington Learning Centers franchisee borrowers.
Experts say industrywide abuse
Bob Coleman, publisher of the Coleman Report for lenders and a consultant to small business bankers, thinks that the situation isn’t limited to just Banco Popular. Most lenders thought future projections were unimportant. "That was pretty much the whole industry that did it that way," he declares. He thinks future financial estimates for a business were never a high priority for bankers in screening the viability of an SBA-guaranteed loan. "Projections were seventeenth on the list," he emphasizes.
"This is a practice that is general with SBA loans in the lending industry," agrees Harry Rifkin, a Maryland-based attorney.
One businessman, John, has been instrumental in pointing out the dubious bank loans to the SBA’s OIG. John told Blue MauMau that he is aware of the OIG tracking over a hundred other bogus loan applications from other lenders that fit the same artificially high earnings profile as the Huntington Learning loans at Banco Popular. It should be noted that all franchisees contacted by this journal, except one, wanted to stay anonymous for fear that their former franchisor might retaliate in court. Because of this, the franchisees have each been given fictitious names, including John.
"Lenders wanted to make sure you weren’t on probation for murder," explains Coleman on how inattentive some preferred lenders were in the past in handing out SBA-guaranteed loans.
The abuse of taxpayer-backed loans by banks generally uncaring about having reasonable business earnings projections promises to go far beyond the rebuke of Banco Popular.
Barbara Arena, who has been an SBA lender for over 25 years with such companies as CIT and now New England-based Granite State Development Corporation, thinks from the SBA Banco Popular report that there will be more investigations to come. After all, the OIG only looked at 12 SBA loans from Banco Popular, out of a batch of 25. "The SBA will get around to everyone else. Banco Popular just may have been the first," says Arena. She thinks for the most part that her lending colleagues have been carefully watching loan applications.
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SBA liar loans involve many banks, franchise systems
According to former franchisees Deborah Williams and Richard Welshans, The Coffee Beanery provided false financial projections for her to put in her SBA loan application, although she didn’t realize it at the time. According to a successful lawsuit by Williams and Welshans, who were represented by attorney Harry Rifkin, The Coffee Beanery fraudulently hid critical information when they bought a coffee shop franchise. A former corporate officer for a national hair styling chain, Williams has pored over her early business documents. She says that The Coffee Beanery knowingly put in astronomic earnings projections of over $400,000 for the first year in her loan application, which was subsequently approved by Sandy Spring Bank of Maryland.
In The Coffee Beanery system, Williams and Welshans weren’t alone in having such high, unsubstantiated numbers. The reality was that the franchising company had already collected revenues from every store and compiled the results in a report called the CB Data Historical Sales Report. According to 50 The Coffee Beanery store revenue reports that Blue MauMau has gathered, first year stores actually performed from a third to a half less than shown in the Welshans and Williams SBA loan application, from a low of $150k to a high of $320k. Most store revenues hovered around $200k. No store reached the estimated minimum sales of $410,000 that was declared on their loan application to Sandy Spring Bancorp. Its numbers were guided by their franchisor and prepared by a lending broker middleman on behalf of the franchisee.
With a lot of hard work and effort, Williams and Welshans managed to perform among the highest for first year franchises. Their store actually brought in $323.690. But that was short of what was planned, was under breakeven point, and was short of what the franchisor said it would be.
Was it just sloppiness in putting down figures or did The Coffee Beanery knowingly distort the numbers?
Records show that the franchisor knew. In a deposition of The Coffee Beanery’s controller Robert Duha at an arbitration hearing, Mr. Duha was asked, "Was The Coffee Beanery aware that except for one, maybe two, that the cafes were losing money?"
"Yes," answered Duha.
And yet the franchisor provided figures on the SBA loan application that showed stores breaking even in order to qualify for the loan. According to Mr. Welshans, franchisor The Coffee Beanery was heavily involved in telling him what numbers to put into the loan application. The former franchisee recalls: "The SBA will never give you a loan on that (revenue projection) said the finance manager at Coffee Beanery." Welshans was told to increase revenue projections by $75,000 for the first year of the cafe. "There are many more franchisees in Coffee Beanery that had the same thing happen to them that happened to me," says Welshans.
Controller Duha wasn’t alone in his testimony. The Coffee Beanery’s former Chief Operating Officer also testified in the arbitration hearing that only three stores out of the system broke even the first year.
"After that, everybody else lost money," said the Chief Operating Officer.
"Was this known to The Coffee Beanery management?" asked franchisee attorney Harry Rifkin.
"Yeah. We weren’t dummies. I mean, we discussed it," the COO answered.
Welshans and Williams feel that they have been misled by the franchisor from the very beginning and never really had a chance. In the end they filed for bankruptcy, lost their house, and for a time wondered if they would be homeless. They feel that the intent of both their franchisor and the bank was to put in whatever was necessary to qualify them to buy a bad concept that never worked, courtesy of U.S. taxpayers.
However, the Williams and Welshans case was not part of the batch that the SBA’s Office of Inspector General examined. The OIG narrowly focused on one bank’s, Banco Popular’s, loans to one franchise chain, Huntington Learning Centers.
Franchisee John paid his banker a fee of $13,000 for underwriting his franchise loan and paid his loan broker $4,000. Not being able to break even for a single month, he folded his business within 18 months. He filed for bankruptcy, losing half a million dollars in the venture, and is now having to sell his home to pay his debts.
What was known was far from what was used in the loan applications. After he bought the franchise, the Huntington Learning Center corporate office in Oradell, New Jersey, published first year earnings for their centers in a February 2008 Huntington Headlines newsletter to franchisees. "Brand new franchise centers increased by five percent from $20,734 per month in 2006 ($248,808 annual) to an average of $21,856 per month ($262,272 annual) in 2007." In contrast, John’s projection in his SBA loan application filled out by the loan broker was $523,000. The projections in the loan were 100 percent higher than the company’s own published first year store average.
When John’s first year settled, his revenues in reality were only $200,000.
Another former Huntington franchisee, Randy, told Blue MauMau that the SBA had contacted him as well. His application mirrored those that Banco Popular had approved. However, his lender was CIT, a giant national lender that recently declared bankruptcy.
Randy went bankrupt in two years.
This is part two 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
This article was republished with permission from Blue MauMau.