Jamar White had no idea what he was getting into when he took out a nearly $50,000 loan with an online lender in 2013 for his New York-based restaurant Buffalo Boss. “Like a lot of small businesses, we made a bad decision by getting into high-interest loans,” he said.
The loan was approved in 48 hours, and at first blush, it seemed like a good deal. “You say, ‘Oh, the lender is only taking $100 off every day.’ But as that compounds over weeks and months, you don’t realize how much is being drained out of your business slowly,” he said.
He later realized that the annual interest rate on his loan was in fact between 40 and 50 percent.
“It’s like a slow death.”
White is just one of the small-business owners around the country who, having failed to secure a traditional loan from a bank, turned to online-based alternative lenders to stay open. What they encounter are loans without clearly stipulated terms and a dearth of regulation and oversight. Business owners who aren’t careful can find themselves in highly uncomfortable positions.
The online lending industry began to take off after the economic crisis of 2008, when banks dramatically curbed their lending to small businesses. The new crop of lenders offer easy access to capital, target small businesses, and provide loans at extremely high interest rates.
“Obviously, small businesses are desperate,” White said. “So they unfairly targeted us in a time of need. I know some companies that went out of business after taking out those loans.”
Attractive but Predatory
Alternative lenders offer a smorgasbord of options: business loans, merchant cash advances, peer-to-peer loans, and lines of credit.
They sometimes approve loans in days, or even hours, because their underwriting criteria are fairly loose, according to Bryan Doxford, senior vice president of the New York Business Development Corporation (NYBDC) and the Excelsior Growth Fund, both provide funds to small businesses at lower interest rates.
White, for example, managed to pay off his debt with a new loan from Excelsior.
According to Doxford, many of the predatory lenders approve loans based on the average daily bank balance of the company they’re lending to.
The loan approval process at traditional banks takes much longer—sometimes months—and they require that applicants provide evidence of a sound financial history.
While online lenders may be attractive because they trade higher fees for speed, they don’t necessarily provide the right types of capital to businesses.
Some of the lenders have misleading language and hidden terms. And because they’re far less regulated than banks, they can often dodge rules that demand clarity. For example, a merchant cash advance is often priced using a “factor rate” or a “multiple,” rather than the more straightforward annual percentage rate (APR).
“You can’t see what the fees and the rates are. ... And if you don’t have a high financial IQ, you can get caught. So they’re pretty good with that,” said White.
In White’s case, the lender simply withdrew the money from his company’s bank account every business day.
Massive upfront fees are another problem. “It is a common tale in our office to hear of a small-business owner who has obtained a loan of $100,000, but has paid a $30,000 fee,” said Doxford.
Other problems are annual interest rates of over 40 percent. “Anything with an interest rate that high is predatory. It’s like a modern-day version of a loan shark.”
California-based Opportunity Fund, the nation’s largest nonprofit microlender, has formed a dataset about the conditions provided by these alternative lenders. They gained the data through their own clients who they refinanced.
They found that the average APR was 94 percent. One loan was for 358 percent, which Opportunity Fund called “shocking.”
For nonprofit lenders like Excelsior Growth Fund and Opportunity Fund, competing with the alternative lenders is a challenge due to their small marketing budgets.
“Most of the time, [business owners] don’t know we exist,” said Caitlin McShane, communications director at Opportunity Fund. “We’re trying to remedy that every day.”
Hundreds of alternative lenders, mostly online, have emerged in recent years, including OnDeck, Kabbage, and BFS Capital. Even Amazon and PayPal now provide loans to small-business owners.
Some online platforms, like Lending Club, Fundera, and Funding Circle, do not underwrite loans themselves but serve as an online marketplace.
To attract more customers, online lenders sometimes form partnerships with traditional banks. They also market aggressively, investing in television, radio, internet, and direct-mail advertising.
There are a few firms that promote responsible lending, such as those who sign the Small Business Borrowers’ Bill of Rights, an initiative launched by the sector two years ago to protect borrowers’ rights that are not shielded by law.
Online lending companies, including BFS Capital and OnDeck, did not respond to Epoch Times’ requests for comment.
Regulatory Void
Many alternative lenders take advantage of their non-bank status that allows them to avoid state usury laws that cap interest rates. They circumvent the regulations intended to shield small-business owners by claiming their credit product is a cash advance, rather than a loan.
Experts are worried that these loans could lead to a looming credit crunch, similar to the credit crisis of 2008.
“I am worried because there are many predatory lenders. A lot of business owners have taken on high interest rate loans and put their businesses at risk,” Doxford said.
He advises that politicians act quickly, before the industry gets even harder to rein in.
The small business sector is a key pillar of the economy and an important driver of employment. Half of all Americans either own a small business or work in a small business, according to the U.S. Small Business Administration.
“When predatory lenders attack Main Street businesses, it has a spillover effect to our wider economy,” said McShane.
