Small-biz cash, with a catch

New breed of on­line lenders aids firms, but in­ter­est rates can top 50%

Los Angeles Times - - BUSINESS - DAVID LAZARUS

Mark New­man needed some fast cash last Oc­to­ber to keep his small Studio City wine-im­port­ing busi­ness afloat. He went to his main bank but was re­jected for a loan be­cause of his rel­a­tively low sales. So New­man, 61, turned in­stead to an on­line lend­ing com­pany called OnDeck. Af­ter sub­mit­ting a hand­ful of bank state­ments, he was quickly ap­proved for a $65,000 loan, which al­lowed New­man to cover his wine ship­ments and keep his busi­ness run­ning. All good, right? Wrong, says New­man. “These loans are preda­tory by na­ture,” he told me. Think pay­day loans for small busi­nesses, he said, with in­ter­est rates well over 30%.

OnDeck is rep­re­sen­ta­tive of a new breed of on­line lenders known as fi­nan­cial-tech­nol­ogy firms, or “fin­tech,” that have found a niche mak­ing money avail­able to small busi­nesses quickly and with min­i­mal hassle.

Just as pay­day and car-ti­tle lenders pat them­selves on the back for meet­ing the needs of cash-strapped con­sumers, these on­line lenders pride them­selves on be­ing there when small busi­nesses re­quire a help­ing hand.

And there’s some­thing to that. Loans with a higher de­gree of risk would nat­u­rally come with higher in­ter­est rates. The ques­tion is whether such loans are be­ing mar­keted hon­estly and fairly, and whether cus­tomers are able to make in­formed de­ci­sions about fi­nan­cial obli­ga­tions.

On­line lenders are a grow­ing eco­nomic and po­lit­i­cal force. Big banks world­wide could lose 24% of their rev­enue over the next few years to fin­tech firms of­fer­ing per­sonal and com­mer­cial loans, ac­cord­ing to a re­cent study by Price­wa­ter­house­Coop­ers.

OnDeck, based in New York, has joined with a hand­ful of sim­i­lar firms, in­clud­ing Kab­bage and Break­out Cap­i­tal, to form the In­no­va­tive Lend­ing Plat­form Assn., a trade group.

The or­ga­ni­za­tion said in an April let­ter to the Se­nate Bank­ing Com­mit­tee that its mem­bers are “ded­i­cated to ad­vanc­ing best prac­tices and stan­dards that sup­port re­spon­si­ble in­no­va­tion and ac­cess to cap­i­tal for small busi­nesses.”

What that means in prac­tice is that these lenders want ex­emp­tions from ex­ist­ing bank­ing reg­u­la­tions.

“Many of the in­no­va­tions brought into the mar­ket by fi­nan­cial tech­nol­ogy com­pa­nies may be re­stricted by ex­ist­ing pol­icy and reg­u­la­tory frame­works that never con­tem­plated an In­ter­net- or mo­bile-based econ­omy and are fail­ing to keep pace with such in­no­va­tion,” the as­so­ci­a­tion said.

Pay­day lenders made a sim­i­lar case in per­suad­ing Repub­li­can law­mak­ers that their busi­ness shouldn’t be sub­ject to fed­eral over­sight. The House

last week ap­proved a bill that says fed­eral agen­cies “may not ex­er­cise any rule­mak­ing, en­force­ment or other au­thor­ity with re­spect to pay­day loans.”

For their part, fin­tech firms have found a friend in Rep. Patrick McHenry, the Repub­li­can vice chair of the House Fi­nan­cial Ser­vices Com­mit­tee. He’s writ­ten a bill, the Fi­nan­cial Ser­vices In­no­va­tion Act, that would es­tab­lish “alternative com­pli­ance” for the reg­u­la­tion of up­start firms such as OnDeck.

Maybe that’s a good thing. Bri­tain has loos­ened its own bank­ing reg­u­la­tions to en­cour­age growth of fin­tech firms.

It’s per­haps fair to think that com­mer­cial loans re­quire less over­sight than con­sumer loans be­cause com­mer­cial bor­row­ers pre­sum­ably bring a greater de­gree of fi­nan­cial savvy to the ta­ble. But a small busi­ness can be just a one-per­son op­er­a­tion — as is the case with New­man’s com­pany, Ac­co­lade Brands.

My worry is that in the rush to em­brace new tech­nol­ogy, au­thor­i­ties charged with pro­tect­ing con­sumers and small busi­nesses end up cre­at­ing an even riskier mar­ket­place.

I also won­der why, new­fan­gled tech­nol­ogy not­with­stand­ing, fin­tech firms are jus­ti­fied in seek­ing dif­fer­ent rules for what re­mains at heart an age-old prac­tice — lend­ing money to cus­tomers.

I asked Chris Wal­ters, ex­ec­u­tive di­rec­tor of the In­no­va­tive Lend­ing Plat­form Assn., what spe­cific reg­u­la­tory ex­emp­tions his in­dus­try is seek­ing. He de­clined to com­ment be­yond the con­tents of the let­ter to the bank­ing com­mit­tee, which of­fered no specifics.

The Fi­nan­cial Ser­vices In­no­va­tion Act is sim­i­larly un­en­light­en­ing. It says fin­tech firms would sub­mit their own alternative com­pli­ance plans, with an un­der­stand­ing that the plans would “serve the pub­lic in­ter­est” and “not present sys­temic risk to the United States fi­nan­cial sys­tem.”

Fair­ness in lend­ing means clear and straight­for­ward dis­clo­sure of terms and con­di­tions. On that score, OnDeck seems to come up short.

For ex­am­ple, the com­pany’s web­site boasts that term loans of up to $500,000 can be ob­tained with an­nual in­ter­est rates as low as 5.99%. New­man said that when he con­tacted OnDeck, he was hop­ing to get a loan at such a rate. But it didn’t work out that way.

“They were crafty about it,” he re­called. “They said they couldn’t of­fer me the lower in­ter­est rate, but they’d see what they could do for me.”

What he got was a 12-month, $65,000 loan, plus nearly $17,500 in in­ter­est and an orig­i­na­tion fee of $1,625. That trans­lated to an an­nual per­cent­age rate of 55%.

In fact, OnDeck told me its av­er­age an­nual in­ter­est rate for term loans, ex­clud­ing fees, is 38%. If that’s the case, I asked why the rate most promi­nently dis­played on their web­site is 5.99%.

An­drea Gellert, OnDeck’s chief rev­enue of­fi­cer, de­clined to an­swer that ques­tion. She said in a state­ment only that “our rates are based on the over­all risk pro­file of our cus­tomers, and short-term loans of 12 months or less typ­i­cally carry higher APRs than longer-term loans.”

Bill Manger, as­so­ci­ate ad­min­is­tra­tor for the fed­eral Small Busi­ness Ad­min­is­tra­tion’s Of­fice of Cap­i­tal Ac­cess, ad­vised start­ing the hunt for cap­i­tal not with a fin­tech firm but with the agency’s LINC search tool (that’s LINC as in Lever­ag­ing In­for­ma­tion and Net­works to ac­cess Cap­i­tal).

The sys­tem will con­nect a small busi­ness with SBA-ap­proved lenders in their area, usu­ally within 48 hours. That may be not as fast as a fin­tech out­fit but, as Manger ob­served, loan ap­pli­cants will still come out ahead.

“I can as­sure that you will have a much, much more fa­vor­able in­ter­est rate,” he said.

De­pend­ing on the loan, that rate may run from 6% to 10%, which is a heck of a lot more palat­able than 55%. That said, the high-in­ter­est on­line loans are eas­ier to qual­ify for.

Also, the SBA re­quires that bor­row­ers per­son­ally guar­an­tee loans if they own 20% or more of their busi­ness. Keep that in mind if there’s a chance you won’t make all your pay­ments, your house or other per­sonal as­sets may be on the line.

New­man said he rec­og­nizes that on­line small-busi­ness lenders like OnDeck pro­vide a valu­able ser­vice for those who need money in a hurry. “I just think they should have to dis­close all the facts,” he said.

I agree. Which is why we should pro­ceed care­fully be­fore giv­ing these firms a longer reg­u­la­tory leash.

David Lazarus’ col­umn runs Tues­days and Fri­days. He also can be seen daily on KTLA-TV Chan­nel 5 and fol­lowed on Twit­ter @David­laz. Send your tips or feed­back to david.lazarus @la­

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