Franchised operations are expected to create 194,000 new jobs in 2011 according to a PricewaterhouseCoopers analysis. This would be a 2.5 percent increase over 2010 and corresponds to a 2.5 percent increase in total retail outlets expected in 2011. Total employment by franchise companies is expected to be 7.8 million this year. That is why the government is focused on financing for small business as a method of job creation.

As reported in The Wall Street Journal , the International Franchise Association conducted a survey of 142 franchisees who reported they expected 2011 to be significantly better than 2010. Of that group, 30 percent considered the lack of credit as having a significant impact on their business and 25 percent considered lack of credit as having a moderate impact on their business. Franchisors similarly need small business financing in order to sell and open franchises. Without funding for small business, the franchisors cannot grow, expand or create jobs. Job relief and franchise business growth have not materialized as expected or needed. The two may be related.

On Sept. 27, 2010, the Small Business Jobs Act of 2010 was passed authorizing the Treasury to create a $30 billion fund called the Small Business Loan Fund (SBLF). The SBLF was offered primarily to community banks having less than $10 billion in assets, to spark small business lending and job creation. The theory is that the SBLF would provide needed cash injections to smaller lenders to loan to small businesses. Like TARP that preceded it, the Treasury purchases preferred stock from the lender in order to provide the capital and liquid funds to lend. The TARP funds were intended to bolster the banks’ balance sheets and provide liquidity for loans, but the banks had little incentive to use the funds for loan.

In an improvement over TARP funds, the SBLF provides an incentive for banks to loan the money. The SBLF preferred stock that the Treasury purchases initially pays the Treasury a preferred dividend of 5 percent; however, the dividend decreases if the funds are used for loans during the first two years and may cost as little as 1 percent if all the loans are made. The preferred dividend to the Treasury will increase if the funds are not utilized for loans, providing a strong incentive for the banks to issue loans.

Until July 2011, no banks obtained any of the $30 billion SBLF funds because of the qualifications required of the banks permitted to utilize SBLF and the strict limitations on the loans. SBLF funds are not available to banks currently on the FDIC troubled bank list, or which had been on the list within 90 days of application for the funds. The SBLF funds are available only for up to 3 percent of the “at risk” assets of the bank, so the maximum a bank could obtain is effectively $30 million. The SBLF funds could be used to retire TARP stock, but the banks could not keep both TARP and SBLF funds. As a result the availability of the funds languished until July 2011, when, finally, $127 million was invested by the Treasury in several banks.

The SBLF is a mere drop in the bucket of funds needed for robust franchise growth. The typical SBLF loan to a franchise company is expected to be $200,000, so a bank could not afford to invest or establish a franchise specialty lending niche and create a pipeline of franchisees seeking startup capital. The limited funds available for the bank from the SBLF prevent aggressive bank investment in the franchise sector. In addition, the loan size is not very large and would not help many of the larger multiunit operators with 20 to 40 units who have proven ability to create jobs and expand. The SBLF may be an improvement on TARP, but it will be ineffective to finance the demand for franchise purchases.

Franchise developers have historically relied on bank loans with a guarantee from the Small Business Administration. Although SBA-backed loans remain available, the number of banks having the liquidity and the processing necessary for a robust SBA lending business has dwindled.

The reason for the paucity of SBA lenders is the lack of liquidity and troubled loans on their books. In addition, the SBA has tightened lending criteria on its loans. Just three years ago, almost anyone with equity in the residence could obtain SBA guaranteed financing. Now, few entrepreneurs have equity cushions for the SBA in their residences.

Moreover, the SBA now typically requires a capital injection or down payment on the business venture of 30 percent, a significant increase over the pre-recession lending criteria. As a result, franchisors have trouble selling new franchises because the banks are not available to lend to these prospects. Even where the loans are made, downsizing by the SBA and banks have created a bottleneck in loan processing.

Congress has recognized the importance of franchising and the relationship between franchise growth, small business lending and job creation. But Congress is treating franchised businesses like the mortgage business and ratcheting up lending criteria unnecessarily. The frequency of foreclosures and defaults due to the mortgage bubble has not been replicated by franchised businesses. Lending to both should not be treated the same. Franchising will grow and jobs will increase when small business lending becomes more available to more entrepreneurs seeking to purchase and expand their franchised businesses. •

 CRAIG R. TRACTENBERG is the chair of the global franchise and distribution practice at Nixon Peabody. He is a former editor of the ABA Franchise Law Journal. Tractenberg can be reached by e-mail at ctractenberg@nixonpeabody.com.