Jason Berry and Stuart Hecker are familiar with the promises – and the pitfalls – of online lending.
In the summer of 2011, business partners were pushing back creditors and struggling to keep the doors open to their Anaheim-based auto repair chain. They asked Wells Fargo for a capital injection but were quickly shot.
Desperate, they turned to the Internet and easily landed a business advance of $ 105,000 with what some would call a lender of last resort. The Deal: Give us 6 percent of your credit card receipts to pay off the debt.
What seemed like a good deal ended up bleeding them dry. The interest they paid, it turned out, was 39 percent.
âWe regretted it within 30 days,â says Berry, managing partner of Becker Tire LLC. “I can’t believe we spent so much money on this thing.”
The once niche market for online alternative loans – popular among small businesses with short or irregular credit histories – has exploded into a multi-billion dollar industry that provides quick and easy financing for everyone from college students to owners. It has caught the attention of deep-pocketed investors and even big banks.
The boom in alternative lending has also become synonymous with loosely worded pricing terms, ultra-high interest rates, and questions about how businesses should be classified and regulated.
For these reasons, the California Department of Business Oversight is examining more than a dozen online loan providers to better understand what they do, how much business they generate, and how they make their money. Many of them are headquartered in California.
Companies under the state’s microscope include Lending Club, Prosper Marketplace and OnDeck, industry heavyweights who have championed peer-to-peer lending – the practice of lending money to people they don’t know. not without the participation of a financial company.
Players like PayPal and Kabbage are also part of the mix, both of which provide cash advances to small businesses. PayPal is first and foremost an electronic payment provider. Kabbage is a financial technology company that uses algorithms to grant credit to small businesses. She recently raised $ 135 million in venture capital.
Officials at the Consumer Financial Protection Bureau, which regulates financial products, say they have “serious concerns” about these companies and want more rules in place to bring them under control.
State and federal regulators are primarily concerned about the ease with which businesses and individuals obtain certain types of financing online and their ability to repay debt. In many cases, borrowers fill out simple forms and can get pre-approved for funds in the tens of thousands of dollars, in some cases within minutes.
These companies measure the creditworthiness of potential borrowers by checking everything from daily credit card receipts to social media presence, essentially creating their own customer scoring models.
“We are not interested in cutting this access to funding,” said Tom Dresslar, spokesperson for the California regulatory agency. “California businesses and consumers have a lot at stake, and we have questions about (if) these lenders are properly licensed and regulated by the state.”
For Becker Tire and Service Center owners, securing their advance was a snap. They suddenly had an influx of funds within 10 days of the request, without having to dig up the reams of documents that traditional banks are waiting for.
But less than a month after getting the money, Berry and Hecker immediately felt the brunt of their repayment terms. The 6% daily deductions by Merchant Cash & Capital were based on daily credit card sales, which fluctuated wildly. So while the payout percentage was fixed, the actual payout amounts were not.
âIt has become very difficult to pay my other bills while paying a fluctuating numberâ at Merchant, said Berry.
It wasn’t until later that they realized they were paying almost 40% interest, he said.
Borrowers in these types of scenarios are often unaware of the online loan APR, which represents the true cost of the loan. Not all lenders will do the math for you.
Merchant, now called Bizfi, claims to have helped Becker Tire when no traditional bank would. The cash advance company has been outspoken about the costs and does not disclose APRs because it does not issue loans, company spokesman Lewis Goldberg said.
âThis is a purchase of future receivables,â he said.
Becker Tire says he received $ 15,000 in a class action lawsuit against Merchant for his financial practices. Goldberg declined to discuss the details of the case, citing a confidentiality agreement.
A study in August by the Federal Reserve Bank of Cleveland found that the average small business owner claims that alternative lender websites make borrowing terms easy to understand. But when asked about specific products, small businesses often answered questions incorrectly, especially about costs.
State regulations exist to govern the disclosure of terms of consumer and business loans. They strive to ensure that borrowers get loan rates that are “fully and clearly” stated and are adequately vetted before being granted a loan, among other things.
WHO IS A LENDER?
But many alternative finance companies don’t see themselves as lenders and argue that they’re technically not subject to state lending laws.
Take Prosper and Lending Club, who claim they only make lending online easier. They say the party responsible for granting the loan is their contractual partner, WebBank, a financial institution in Salt Lake City.
On a related note, companies like PayPal and Square call themselves money transmitters. Companies like Kabbage don’t give loans either; they give cash advances, similar to what Berry got through Merchant. Businesses âadvanceâ the money to the business and deduct payments on a daily, weekly, monthly or bi-monthly basis to recover costs.
âThey’re essentially bypassing state regulation,â said Eric Weaver, director of the Opportunity fund for nonprofit microlenders.
Some of the lenders being investigated by the state say they are disclosing the terms of the loan. Bond Street said it provides customers with both the interest rate and the APR in all of its loan offerings. SoFi, which refinances school loans, told the Registry in a statement: âFairness and transparency are critical factors in our partnership with our members, and we strive to have an equally transparent approach with regulators.
The remaining lenders declined to comment, did not respond to requests for comment, or simply confirmed the investigation.
Ironically, a growing line of business for traditional small business lenders is helping borrowers navigate lending issues online, says Kurt Chilcott, managing director and president of CDC Small Business Finance.
In late 2012, CDC agreed to refinance Berry’s loan with Merchant and turn it into a $ 125,000 loan backed by the Small Business Administration at prime plus 3.75%, which equates to about 7%.
DO NOT SLOW DOWN
Refinancing may not be possible in all cases, especially when borrowers have taken on too much debt by taking out a series of loans online to pay off previous ones – similar to the vicious cycle victims of payday lenders experience.
Despite the problems, there is no indication that online lending will slow down anytime soon.
Some of the biggest names are growing with the backing of Silicon Valley venture capitalists. Lending Club went public at the end of 2014 with a valuation of $ 9 billion.
And traditional big banks – seeing their retail branches and lending operations shrink – are looking to tap into the alternative lending market.
JPMorgan Chase recently signed a partnership with OnDeck, and JPMorgan will use the online lender to provide quick access to small business loans. The service operates under the name and capital of JPMorgan.
Some of the money that flows into online lenders is recycled into intensive marketing.
Berry, the owner of the auto store, experienced it. Since paying off the merchant loan, he has regularly received letters, emails and phone calls from similar cash advance institutions.
“They say, ‘So you say you not you want some money ? They try to make you feel stupid because you didn’t take the money, âsays Berry.
Contact the author: [email protected] or 714-796-4976 Twitter @LilyShumLeung