Searching for Capital
A broker assesses the small-business lending market.
In my loan brokerage, the phone often rings with small-business owners who want cash quickly for a wide variety of reasons. They may be in a desperate situation, or they may be so fed up with the local banks that they don’t even want to try that route. Or perhaps they’ve been told by friends how frustrating it can be to apply for a Small Business Administration loan.
In many cases, these owners are calling to because they want to know more about merchant cash advance loans, which can be very appealing. They can get money in a few days, and they pay it back with payments that come out of their revenue, typically over a six-month period. “We will lend you $30,000, and you will pay us back $36,000 over six months,” the sales representatives say.
The business owner is enticed, thinking, well, it will only cost me $6,000 — and the interest rate is only 20 percent. The reality, though, is that the interest rate is more than 40 percent, because the term is only six months. And because the term is so short, the business owner is often forced to renew the loan before it’s paid off. If owners do this more than once, their debt expenses can spiral out of control.
These alternative lenders have received a lot of publicity of late. OnDeck Capital, for example, recently announced big investments from the likes of Peter Thiel and Google Ventures. The company borrows money from investors, including Goldman Sachs, and then turns around and lends it in the small-business market at much higher rates. Another alternative lender, Kabbage, which has a different business model, recently announced that it is the first lender to use QuickBooks data to underwrite small-business loans. A Kabbage loan works more like a short-term line of credit, with the merchant making payments monthly instead of daily. On its Web site, Kabbage states that its fees run between 2 percent and 10 percent percent in each of the first two months of a typical loan and then 1 percent a month for the last four months.
As I read these articles, I am torn between being genuinely impressed by the innovation and technology spawned by these companies and feeling the pain that I know their interest rates can cause. I feel these emotions even more strongly when, other options exhausted, I put my own clients into these types of loans — after first advising them of the risks.
I understand that there will always be a broad range of supply and demand in small-business lending. There will always be people or companies willing to lend to almost anybody for the right price. And I also understand that regulators will often be years behind the changes that occur in the industry. And whenever a new set of regulations takes hold, the high risk lenders are likely to shift directions any way. I don’t think this will change. But I do think it’s important to ask whether it should be considered acceptable for established corporations and reputable brands to invest in these lenders and lend them money that will in turn be loaned to small businesses at much higher rates.
The annual percentage rate on an On Deck loan can be as high as 60 percent, which is high enough to make most rational business people shake in their boots and has been termed “near usurious” in Forbes. When the mayor of New York recently honored On Deck with a visit to its new offices, I wondered whether his staffers had briefed him on the interest rates the company charges small businesses. On Deck argues that its prices are considerably lower than those charged by other players in the cash-advance industry, and that is true.
Companies like Advance Me and RapidAdvance charge rates that can exceed 100 percent. And they are backed by Wells Fargo, which mystifies me. I don’t understand how a federally regulated bank can borrow money from the government and then turn around and lend to alternative lenders that charge small businesses those kinds of rates.
Again, though, I do think there is a place for accredited, reputable lenders that innovate and that are willing to take more risk then banks take. And these alternative lenders should be paid more for the risk they take and the additional service they provide. I know many of the entrepreneurs who started these companies, and I don’t believe that their agenda is to try to damage small-business owners. They are technologists who set out to build platforms to try to make the lending process more efficient and to open up opportunities. And in many cases, they have done just that. They have accomplished things that would have taken the big banks decades to develop.
I also know many of the investors behind these companies, and their focus is not on the high annual percentage rates. These investors are thinking about disruptive technologies and big opportunities. Alternative lending to small businesses fits perfectly into their sweet spot. They are doing their jobs, answering to the people who invest in their funds.
What I wish these companies would do is to set some standards. This would include a commitment for clear and transparent loan pricing and plans to help their clients graduate out of their financing, so it does not become permanent. I would also like to see them leverage their entrepreneurial spirit to try to drive rates down for creditworthy small-business owners. And they could do a better job reporting on their loan volumes.
By coming together, setting standards and striving for improvement, the alternative lenders could bring credibility to an industry that needs it.
Ami Kassar founded MultiFunding, which is based near Philadelphia and helps small businesses find the right sources of financing for their companies.
Article source: http://boss.blogs.nytimes.com/2013/05/22/why-alternative-lenders-should-set-some-standards/?partner=rss&emc=rss