By Becky Yerak
WWR Article Summary (tl;dr) Technological advances and big data are changing how consumers and small businesses get financing. Online lenders can provide small-business borrowers with faster access to credit than they can get through the traditional face-to-face application process. However, while online lending is growing in popularity the practice is also drawing scrutiny.
When Steve Buresh’s Cheesecake Store & Sandwich Shop opened in suburban Chicago in 2014, patrons couldn’t get enough of the desserts he had made for friends and family since he was a teenager.
Buresh needed a bigger mixer and a new oven pronto. After traditional bankers told him a small-business loan could take up to three months to get, Buresh turned to an online lender that offered credit, fast.
“I would have looked into more options, but, being a small-business owner, I didn’t have a lot of time to go back and forth to banks,” said Buresh, who initially delivered his homemade goodies in a food truck.
Days after signing for the loan, Buresh regretted it. On top of interest and fees he regarded as draconian, the lender deducted a set amount daily from his checking account. “If we got slow, they would still take that amount, and some weeks I had a hard time paying my staff and bills,” said Buresh, 37.
His final tab for a $19,500 loan for nine months: about $25,000.
Technological advances and big data are changing how consumers and small businesses get financing. Online lenders can provide small-business borrowers with faster access to credit than they can get through the traditional face-to-face application process, and, with studies showing only about half of entrepreneurs getting the financing they apply for, alternative lenders see an opening. Their higher profile and growing popularity, however, are drawing scrutiny.
In Illinois, for example, state senators in April introduced the Small Business Lending Act, which targets online financiers making small-business loans of $250,000 or less. The act, met with broad resistance despite its exemption for banks and credit unions, requires lenders to be licensed and to clearly disclose, among other things, the annualized interest rate of a loan, including fees, and the total amount a borrower would pay over the course of the loan. It also would require lenders to assess a borrower’s ability to repay a loan; limit various fees; and ensure that electronic fund transfers are a choice, not a requirement, for repayment.
In a report about online lending last month by the Treasury Department, a common theme was how small-business borrowers might need improved safeguards because protections for them aren’t always as robust as they are for consumers. Online lenders to small businesses include OnDeck, Funding Circle and Bond Street, whose loans carry annual percentage rates ranging from 6.9 to 98.4 percent, Treasury said.
One reason banks don’t go out of their way to lend to the Etsy crafts people or food-truck operators of the world: It costs banks about the same to underwrite a $5 million loan as a $200,000 loan, Treasury said.
On $100,000 loans to small businesses, banks can even lose money, or, at best, break even, due to high underwriting and compliance costs, PayNet, a provider of credit ratings on small businesses, told Treasury during a public-comment period last year.
Chicago-based Dude Products, which makes wipes for men, used online business lender Kabbage to help finance a product rollout.
Dude CEO Sean Riley learned of the lender in 2014 through a Facebook ad and quickly received $15,000 at an interest rate of about 10 percent. “We hadn’t been in business for two years, and banks were asking for two years of tax returns,” Riley said.
Although Riley had a good experience with Kabbage, and although 1 in 5 small businesses seek credit from online lenders, the sector’s customer satisfaction scores fall short of banks due to concerns over high interest rates and unfavorable repayment terms, the Fed study said.
Laura Soncrant, owner of Chicago restaurant Growling Rabbit, got a loan from online lender OnDeck within a day last year after unsuccessfully trying to get credit from banks at which she had her mortgage and business accounts. Soncrant, who is moving her eatery to a bigger place that will be open longer hours, found OnDeck’s terms “transparent.”
Last December, OnDeck gave her a $48,000 loan with an interest rate of 35 percent, and a $30,000 line of credit with an interest rate of 24.9 percent.
“While the rates for your initial OnDeck loan could seem a bit high, it’s important to note rates can go down with each loan you receive based on your payment history,” Soncrant said. “The flexibility of the loan structure was very important, and since I have not yet needed to use the line of credit, I am not paying the higher interest for money I did not need at the time but wanted access to if needed.”
In December 2015, cheesecake maker Buresh struck a deal with Accion, a nonprofit whose services include small-business loans, to provide him with additional working capital and to refinance his loan with his online lender. That improved his cash flow, said Kate Novotny, a senior loan officer at Accion.
Accion also helped Buresh, who comes from a family of restaurateurs, get a $70,000 Small Business Administration loan to help him with storage, equipment and a van, among other things.
“We’re on our way to hiring more staff and building our business,” he said.
Shortly after Tsadakeeyah Emmanuel, 52, of Chicago, started Majani Catering, a vegan catering business, in 2013, his delivery van broke down. Needing money for a down payment on a new vehicle, he borrowed $4,000 from an online lender. The interest rate was 75 percent.
“We didn’t have enough of a track record” for a bank loan, he said.
Worried about falling behind on payments, he worked a second job as an Uber driver, and paid off the loan within four months.
To expand his business and build a restaurant and kitchen, he recently qualified for a $30,000 loan, this time from a nonprofit lender, Chicago Neighborhood Initiatives, that offered a rate of 10 percent.
“They were the first institution to say, ‘We trust you,'” said Emmanuel, who remains wary of online lenders.
“When you read the fine print and start reading about daily debits, that should scare the bejesus out of anybody,” he said.
“You shouldn’t be able to charge someone a 100 percent interest rate.”