As a small business, it is important to understand your loan options.
Online lending for small-business owners has quickly become a big (and largely unregulated) business, with Morgan Stanley estimating that these lenders will lend out $7.9 billion this year. And with the increased activity, regulators in Washington are starting to open their eyes and ask questions.
As in any Washington D.C. showdown, different groups are preparing for a fight. And while I can’t predict how things will end up, I think it’s fair to say that there will be two fundamentally different camps.
One group will be comprised of representatives who promote short-term on-line loans or cash advances. There are hundreds of companies either lending or brokering these products. The second group will involve lenders who offer term loan products with 2- to 5-year terms. While unfortunately these lenders don’t have a name, I like to call them investment lenders, as borrowers have time to invest their funds and pay them back over time.
In my mind, these two groups represent two fundamentally different business practices-and it’s important for the small-business community to understand the differences between shorter term and investment lenders. The difference is in the transparency and safety of the loans they make.
Here are the key differences.
1. Investment lenders provide a transparent interest rate. Shorter term lenders use “factor” pricing. While factor pricing is simple on the fae, borrowers often get it confused with an interest rate, and can often think that the money is four times cheaper than it is. A study by the Federal Reserve recently confirmed that “mom and pop” businesses are grossly confused by this short-term, less transparent pricing.
2. The short-term advances and loans often result in borrowers stuck in expensive cycles of re-borrowing, like a payday loan. Many short-term lenders juice their returns by double-charging the borrowers every time they renew, in a practice called “double dipping.” Longer-term financing can better help businesses grow.
3. Longer term lenders typically have no pre-payment penalties. Short-term lenders have no pre-payment benefits. So if the borrower can pay back in a month instead of six months, they’re still responsible for the entire amount.
4. Interest rates for longer term lenders typically range from 6 to 32 percent. Meanwhile, I have seen paper issued from short-term lenders with interest rates ranging from 40 to 200 percent.
5. There are a handful of lenders and brokers promoting short-term loans. There are far fewer advocating the longer term loans.
When you’re looking for an on-line loan, be very careful which product you choose.
(My company MultiFunding is a proud founding member of the Responsible Business Lending Coalition, which includes many of the investment lenders. I am not writing this piece on behalf of the Coalition. These opinions are my own.)