Small businesses increasingly seeking online lenders
Lisa Plassio was seeking a loan to buy inventory for her furniture store, but no bank was interested.
“The banks wouldn't even acknowledge me,” said Plassio, who owns Home & Office Consignment Gallery in South Park. “I had my business plan and they wouldn't even look at me.”
It was the height of the Great Recession, a period when credit was tight and banks were especially reluctant to take on the risk of financing a small businesses. But Plassio found an alternative online.
She took out a short-term loan of several thousand dollars through an outfit called Merchant Cash and Capital, now known as Bizfi. Fast and convenient, online lenders became her favorite option for financing her business and, seven years later, Plassio says she has no interest in using traditional banks.
Small businesses increasingly are turning to alternative lenders as banks focus on larger customers. Online lenders provided an estimated $7.9 billion in small-business loans last year, up 68 percent from the year before, according to Morgan Stanley.
Hundreds of alternative lenders have sprung up in an industry led by companies such as OnDeck Capital and Kabbage, giving small businesses easy access to cash advances and loans. With just a few clicks, businesses can get approved for hundreds of thousands of dollars and have the money in their bank accounts within minutes.
The industry has begun to attract the attention of traditional banks, which are starting to partner with and even acquire these venture-backed online lenders.
But the industry's rapid rise has also raised questions about what, if any, rules are needed to rein in their practices to protect borrowers.
Alternative lenders are not regulated like traditional banks and their standards can be loose, often based on little more than a businesses' credit score. Small businesses are not guarded by the majority of consumer lending laws that provide clarity on the costs of borrowing.
Lenders, for example, don't have to disclose information like annual percentage rates and have a great deal of flexibility in how they describe their loan products.
That has led business owners to sign up for cash advances, loans or lines of credit without understanding how much they would be paying, said Ami Kassar, CEO of MultiFunding, an Ambler, Pa., company that connects small businesses with lenders.
The effective APR that online lenders charge for some loans can be more than 100 percent, starting many small companies on a path to financial ruin, he said.
“I don't think that the current system is sustainable,” Kassar said. “We literally are in a situation in this country where we have ‘banks' being run out of garages. A lot of times, people don't even know who they're borrowing money from.”
Kassar doesn't dismiss the entire industry. Some companies, such as Lending Club, have tried to be transparent on costs and loan terms. And there is a real need for financing small businesses that traditional banks have ignored, he said.
Small business loans from banks are down about 20 percent since the financial crisis as lending standards have tightened and small businesses continue to repair their credit from damage of the recession, according to Harvard Business School senior fellow Karen Gordon Mills. Loans to larger businesses have risen 4 percent in the same period.
The ease and simplicity of applying for online loans has made them appealing, said Ann Marie Wiersch, senior policy analyst at the Federal Reserve Bank of Cleveland. But the lack of industry-wide disclosure standards makes it difficult to compare products.
In a study last summer, Wiersch found that owners of small businesses — fewer than 20 employees and under $2 million in annual revenue — struggled to understand the costs of borrowing.
“They had challenges really comparing products,” Wiersch said. “There's different communication strategies that we've seen with these lenders that don't translate to an APR that a borrower may be used to seeing on a mortgage or even credit card.”
Plassio said she was “a little confused” when she took out her first loan with Merchant Cash and Capital. Her loan repayments were based on a percentage of her credit card sales and deducted from her bank account daily, she said. The amounts varied widely.
“It would be like $120 on one day, but if I had a really good day, they could take $300 to $400,” she said.
A few industry leaders have taken steps toward self regulation by establishing a Small Business Borrowers' Bill of Rights, which calls on lenders to be transparent with rates by disclosing APRs, using no hidden fees or penalties, and pledging no “abusive products” that would put borrowers into debt traps.
Lending Club co-created the bill of rights and has pushed other lenders to commit to the standards it lays out. The document may also serve as a template for regulators, said Tom Green, Lending Club's vice president of small business.
“We're not saying a regulator should come in and say exactly this, but at least we're saying what we think would give some guidance to potential future regulatory action,” he said.
Last summer, the U.S. Treasury Department sought public input on the industry and how it might be regulated, though so far it has made no formal proposal.
Stricter oversight might be coming anyway as alternative lenders merge with traditional banks. In 2014, CIT Bank acquired online lender Direct Capital Corp. Now, as a division of CIT Bank, Direct Capital is federally regulated. The company still operates with the speed and efficiency of an online lender, but discloses fees and APRs on all loans, said Steve Lankler, senior vice president of marketing at Direct Capital.
“Transparency is extremely important,” Lankler said. “Small business owners should be able to easily understand exactly what they are committing to.”
Nick Vacco, owner of an auto detailing products business in Plum, said he's never been confused about the costs of borrowing from PayPal Working Capital, the small business lending division of the payments company.
He shopped several online lenders and calculated the costs himself before choosing one.
“I just took the amount that I wanted to borrow and looked at what the fee would be and then I determined what that percentage was,” he said.
Plassio is a customer of Direct Capital, having switched from Bizfi five years ago because she preferred the payment structure. She uses Direct Capital for cash advances of about $20,000, which she pays back over a nine month period, deducted daily in set amounts from her account.
The process is fast — she can apply on Monday and have the money in her account by Friday, she said.
Now, Direct Capital is her primary lender. And the traditional banks that once showed no interest from her?
“There is no interest in them from me,” she said.
Chris Fleisher is a Tribune-Review staff writer. Reach him at 412-320-7854 or firstname.lastname@example.org.