Borrower protection initiatives have taken aim at predatory lenders, both online and brick-and-mortar, with legislators at the state and federal levels addressing concerns that include a lack of transparency and sky-high fees and interest rates.
But only recently have these efforts begun to gradually turn toward small business borrowers, too.
Last month, reports in The Wall Street Journal, citing Federal Reserve data, found that nearly one-third of U.S. small businesses had sought a loan online, compared to just 19 percent that did so in 2017. As online lending platforms proliferate among the SMB borrowing community, however, experts warn that a lack of regulation means these companies rarely publicly reveal interest rates and fees.
As the publication noted, Opportunity Fund recently dug into the numbers and found that the average interest rate among 150 online small business loan contracts is 94 percent, with one rate topping 358 percent.
One might think that once a borrower is presented with a 358 percent rate, they'd run – fast.
But according to Pat MacKrell, president and CEO of New York-based small business lending firm Pursuit, the online alternative lending market has gotten good at hiding the true cost of financing from SMBs.
"We shouldn't allow businesses to be confused about the difference between a fee and an APR," he told PYMNTS in a recent interview, pointing to one small business borrower he has encountered that misinterpreted a 25 percent fee on a four-month loan as a 25 percent APR. "We have seen small businesses destroyed by online lending."
Knowing Their Options
There is a trove of reasons why a small business might choose an expensive online loan over, for example, a Small Business Administration (SBA) loan, which is often the most affordable option.
In addition to a lack of transparency among online lenders, MacKrell noted that small business owners are working 24/7 to put out the most immediate fires. They rarely have the time or resources to aggregate their financial data and understand their current cash flow situation, let alone educate themselves on the complicated lexicon of the lending industry.
When it comes time to apply for financing, he said, it's often because there's an emergency – they must make payroll or find cash for an upcoming tax bill, for instance. At this point, these business owners will flock to the most convenient and visible option, which is increasingly becoming digital alternative lending platforms.
While these tech-friendly companies may have the marketing strategy to place Facebook ads in front of small business owners, many of these entrepreneurs are largely unaware that an affordable SBA loan is even an option, said MacKrell.
"The SBA has not been as proactive as it should be in making it known to borrowers what it takes to get an SBA loan," he said. "I don't think the SBA has even been proactive in giving borrowers the ability to distinguish between the various products the SBA offers."
Often, he said, small business owners simply assume they would get turned down for traditional financing. On top of that, MacKrell said the government is not sufficiently enlightening the small business community about the risks of online lenders.
"These loans are being applied for by people who have worked all day long," he noted. "The fact is, they're not currently provided with enough information to make a reasoned choice about what they're getting."
Taking a Local Approach
MacKrell emphasized the role that federal and state government initiatives can play in increasing awareness among SMBs about online lending risks and the potential for more affordable financing options – with New York quickly becoming a key battleground for the nation's small business borrowers’ protection movement.
MacKrell highlighted the work of U.S. Representative Nydia Velazquez (D-NY), who recently called on lawmakers during a House Small Business Committee Hearing to address predatory small business lending (in particular, lenders' use of confessions of judgment that require small businesses to accept liability and damages without traditional court proceedings).
At the state level, New York Governor Andrew Cuomo signed legislation in August to curb the use of confessions of judgment.
According to MacKrell, the small business lending industry's own players have a role to play, too, and taking a local approach to SMB lending can be particularly effective. He highlighted the ability for companies like Pursuit – which focuses on small businesses in Pennsylvania, New Jersey and New York – to actually work with borrowers in-person to provide advisory services and improve SMBs' awareness of their most appropriate borrowing options.
With online lenders growing in popularity, the industry is likely here to stay – and not every platform presents a dangerous choice for a small business. Indeed, thanks to their digital-first approach, financing via one such platform can offer a convenient, strategic source of capital for growing SMBs.
But what's crucial is that these small businesses are armed with all of the information they need to make an informed decision, as MacKrell noted.
"We support and advocate for legislation that provides transparency that allows businesses to completely understand the impact of a daily loan payment on their cash flow," he said. "For a small business to start, sustain and scale operations, they need a 'friend in court,' so to speak."