As an essential engine of the American economy, small business has a big impact. But where can small business owners turn for the capital they need to grow? Traditional lenders are one option, but the “It’s a Wonderful Life” image of George Bailey at the Building & Loan may not reflect reality. New online options may broaden the availability of credit, but they also raise some consumer protection concerns. That was the topic of Strictly Business: An FTC Forum on Small Business Financing and you’ll want to read a new FTC Staff Perspective on the subject.
According to Federal Reserve statistics, in 2018, 32% of small businesses reported applying for online financing – up from 24% in 2017 and 19% in 2016. Many lenders are new to the market. Some base their underwriting on financial technologies and alternative data. In addition, payment processors and technology platforms have entered the arena, offering financing based, in part, on what they already know about small businesses from their credit card receipts or sales data. Other players include nonprofit microlenders that attempt to offer affordable loans to underserved borrowers.
It’s not just the “who” that’s new. The “what” may be new, too. Online companies offer a wide range of products. Some involve flat fees, rather than interest, or may require weekly or even daily repayment. Then there’s the generally higher-cost, short-term option of the merchant cash advance. MCA providers buy a fixed amount of a small business’s future receivables. The business must repay the advance plus a “factor” – often between 20% to 50% of the amount. Daily payments may rise or fall based on daily sales.
The Staff Perspective cites some potential benefits to online financing. Providers promote a simpler application process with customizable terms. Additionally, because they may base decisions on real-time sales data – more than a business owner’s personal credit score – companies may extend credit to borrowers who might have been turned down in the past.
But then there are the consumer protection considerations. You’ll want to read the Staff Perspective for a deeper dive, but here are some issues flagged at the Forum:
- Inconsistent information. Non-traditional products may offer different terms and terminology. Are these differences creating inconsistencies that make apples-to-apples comparisons more difficult?
- Consumer confusion. A related concern is whether small business owners grasp the nature of new products. “But they’re in business,” some have said. Yes, but their understanding of the terms may be more akin to consumers in personal credit transactions. In a Federal Reserve staff study, business owners expressed confusion about costs, often underestimating what they would have to pay. The Staff Perspective discusses how state legislation and self-regulatory codes are attempting to address those issues and how the FTC Act’s prohibition on deceptive and unfair practices would apply.
- Concerns regarding merchant cash advances. Panelists at the Forum and others have expressed a number of concerns about MCAs: 1) Some businesses desperate for quick funding may struggle to repay MCAs, which can have estimated APRs in the triple digits; 2) MCA providers and the brokers and lead generators they use may employ misleading practices to promote their products; 3) When daily sales drop, some MCA providers may not conduct promised “true-ups” or reconciliations to reduce merchants’ payments; and 4) Some providers and their agents may use potentially abusive collection practices. One particular concern raised by panelists: Some in the MCA industry require owners to execute a confession of judgment, a document waiving their rights to contest any lawsuit to collect unpaid amounts or fees. You’ll want to read the Staff Perspective for more details.
Has your small business ventured into the online financing marketplace? If you’ve experienced questionable practices, the FTC wants to hear your story.