One of the main results of the banking crisis that brought the Great Recession was a new law created to protect the consumer through the Consumer Financial Protection Bureau. Unfortunately, this has only moved the focus for predatory lenders to small businesses.
Desperately seeking cash, these owners are now at risk of borrowing money for their companies and not fully understanding the terms of their loans. The subprime lending industry has exploded to $3 billion. These loans are still unregulated and are not protected by the same laws that cover individual borrowers. Mark Pinsky of Opportunity Finance Network says “[For subprime business lenders] the sweet spot is someone who can limp along well enough for six months but probably isn't going to be around much longer…They’re in the business of helping these businesses fail.”
According to Bloomberg Businessweek, one of the companies specializing in subprime lending – also referred to alternative lending – is World Business Lenders. The firm’s representatives pitch their high-rate loans to small business owners who have trouble borrowing elsewhere. World Business Lenders seizes collateral such as vehicles and other assets when borrowers can’t pay, and press legal action where World Business sues companies for missed payments, often sending companies into bankruptcy. In fact, 20 percent of World Business’s borrowers were forced to close down last year, according to former executives.
This capital comes from well-known sources. One subprime business lender, OnDeck, has credit commitments from financial lenders like Goldman Sachs. Interest rates on loans from OnDeck range from 29 percent to 134 percent.
Sales representatives of these types of lenders can use confusing terminology such as “short-term capital” and discuss “money factors” instead of interest rates when talking to potential borrowers. Here are steps you need to take before signing any loan agreement:
- How much are you borrowing? Know the exact amount you will receive after any application, up front or prepaid fees.
- What is the actual annual interest rate? Make sure you understand in writing the nominal and effective annual percentage rate.
- What is the borrowing term? How often do on time payments need to be made? What are the penalties for late payments?
- Are there other fees for paying off the loan early? Some agreements apply all the term interest even if the loan is paid ahead of schedule.
- Is there a personal guarantee? Are just the officers of the company signing the documents or do you need to personally guarantee it as well? Stay away from these types of guarantees that can put your personal savings and home at risk.
- Don’t rush it. Don’t be in a hurry to sign any document. Think about it for a day. Show it to a professional advisor (or a banker) to get their opinion on this source of capital.
Always look at all other available sources of capital before agreeing to this type of loan. Check for help from friends, family, customers and additional business cash flow management.