If you’re running a small business, you’re likely seeing a flood of easy-to-obtain loan offers – through direct mail, pop-up ads, even TV commercials – promising quick cash to pay your bills or buy new equipment. But with this new world of fast money comes some expensive holds.
“It’s the Wild West,” said Karen Gordon Mills, co-author of a just-published Harvard Business School study exploring the promises and challenges of alternative small business lending. The sector has exploded in recent years with the emergence of a new industry called “fintech” (for financial technology).
Typically, to get a loan, a small business owner needs to provide a bank with tax returns, personal and business financial statements, and a stack of other documents and data. “You have to wait weeks or months,” said Mills, who co-authored the report “Small Business Loans: Innovation and Technology and the Implications for Regulation” with Brayden McCarthy.
In addition, there has been a persistent “credit deficit” – a dramatic lack of funds available for small businesses in need of smaller amounts of money, less than $ 250,000.
Today, dozens of companies – OnDeck, Kabbage, FundBox, BlueVine, Prosper and the scandal-outraged Lending Club – are eager to lend money to small businesses. In addition, a number of platforms – Fundera, NerdWallet, Quickbooks Financing, Biz2Credit, and Lendio – have emerged to connect small businesses with these new lenders.
Fintech lenders use more current and digitized information than traditional bankers. For example, with permission, they can directly access a company’s QuickBooks accounts. “You get your answer in minutes or hours, and you get your money’s worth in hours or days,” Mills said. “It’s transformative.” Because it is easier to reach potential borrowers and assess the risks, they can offer profitable loans “even as low as $ 7,000 to $ 10,000”. Such loans have been practically impossible to obtain from a bank.
But there is a catch. “No federal regulator has authority over small business borrowing like they do over consumer borrowing,” Mills said. “The Truth About Lending Act doesn’t apply to small business borrowers, so you don’t have transparency. Small businesses might not know what they are paying.
As a result, these new lenders can – and often do – charge exorbitant interest rates and accumulate fees, often hidden from the borrower. A short term loan can turn into a long term nightmare.
“There is so much promise in the rise of lending in the small business market,” said co-author McCarthy, vice president of strategy for Fundera, an online lending platform. “This has been ignored for a long time, but we want to make sure that the disclosures are strong enough that borrowers know what they are getting into. “
Some issues identified in the Harvard Business School report:
- High costs. Lenders typically charge APRs (Annual Percentage Rates) above 50% and can easily go over 300%.
- Double soaking. Recurring borrowers incur additional fees each time they renew their loans.
- Hidden prepayment charges. Unlike traditional loans, many alternative lenders require payment of full interest even when the loans are prepaid.
- Incentives from misaligned brokers. Small business loan brokers often recommend the more expensive loans because they charge the highest fees on them.
- Stacking. Several lenders provide loans to the same borrower, resulting in additional and hidden charges.
It is not enough to say “let the buyer beware”. Understanding how much a loan actually costs is difficult, even for sophisticated borrowers. “A Harvard MBA class was asked to decipher the APR on loans less than one year old, factoring in original fees, closing costs, other fees. Forty percent were former investment bankers or came from the financial world, ”McCarthy said. “More than half were wrong.”
“We are not asking for new regulations,” said Mills, “but for streamlining of existing regulations. With the new president, we know there will be new legislation. … Let’s make sure small business borrowers are protected. But let’s also make sure that lenders have a chance to close that credit gap. “
What the Harvard Business School report recommends:
- Mandatory disclosure of APRs, fees, default rates and borrower satisfaction
- A national regulatory option – rather than state by state
- Increased borrower protection for small business owners
- Rules / guidelines on partnerships between banks and new lenders
- Brokers / platforms have a “fiduciary” duty to borrowers, which means they must act in the best interests of borrowers and disclose conflicts of interest
Rhonda Abrams is the author of 19 books including “Successful Business Plan: Secrets & Strategies” which is in its sixth edition. Connect with Rhonda facebook.com/RhondaAbramsSmallBusiness and twitter: @RhondaAbrams. Sign up for the free Rhonda Business Advice newsletter at www.PlanningShop.com