Paying business debts before home mortgages, Part II

Posted by: John Tozzi on September 11, 2008

Just a brief follow-up on the item I posted Monday on how business owners are paying their commercial debts even as many fall behind on home loans. In the comments, Carol makes a good point: that for franchise owners, there’s often not much of a choice.

[T]hose small retail franchise business owners who have used SBA Loans to finance the startup of their franchised businesses will always pay FIRST their SBA Loan and royalties to the franchisor, and their lease payment to the business Landlord, and their debt to suppliers, because if they default on their business loan or their lease or the royalry payment to the franchisor (assessed on their gross sales and NOT on their profits) they will lose everything invested in their business almost immediately under the terms of the contracts they have signed with the franchisors. Franchisees are required to sign personal guarantees to get business loans and to post collateral and when they lose their businesses they often lose their homes, as well.

Maybe there’s a similar calculation for any business owners who have personally guaranteed business debts. If they default on their business payments, they risk their personal assets as well. So if they’re forced to choose, they’ll pay the commercial debts first to at least keep the business alive, even at the risk of losing their homes.

But the point about franchisees is worth noting. They face more in up-front costs and royalty payments than independent businesses. Many may not be choosing to pay their business debts first so much as they’re backed into doing so.

Reader Comments

Carol

September 11, 2008 7:09 PM

Apparently, the SBA software programs have not been that successful in separating out franchise loans from the independent small business loans, or in tracing defaults on franchise loans, as separate from loans for an independent business. (According to the head of FranData in a recent interview with Coleman.)

This is unfortunate in that the statistics concerning franchise and independent small business startups and failures and defaults will be mingled in SBA Data and in other data bases such as used for your report.

I believe FranData, who manages the SBA Franchise Registry for the SBA, indicated that the banks/lenders really shouldn't rely on the SBA data because the two programs didn't work that well together.

Another reason, the independent business owner will pay his commercial debt FIRST, just like the franchise business owner, is that he is free to sell his business or his business assets in the marketplace for whatever he can get for the business in a timely manner.

As you know, franchisees cannot freely sell their businesses because their franchisor, by contract, has a first option to buy the business, and if the franchisor doesn't exercise his option, the delay in approving a buyer, a new franchisee-owner, very often works greatly to the disadvantage of the stressed franchisee.

Franchisors often have 60 to 90 days under contract terms to approve or disapprove a new buyer and to transfer the franchise rights. When a franchised business closes its doors due to financial stress, the BRAND franchisor considers that they have abandoned the business, and terminates them. The franchisees have no business to sell under the terms of the franchise agreements.

Big difference and worth noting.

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What's it like to run your own company today? Entrepreneurs face multiple hurdles new and old, from raising capital and managing employees to keeping up with technology and competing in a global marketplace. In this blog, the Small Business channel's John Tozzi and Nick Leiber discuss the news, trends, and ideas that matter to small business owners. Follow them on Twitter @newentrepreneur.

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