Not Just Cookies, a wholesale and e-commerce bakery in Chicago, is growing. Johnathon Bush, company founder and baked goods lover, opens additional locations in Chicago and soon also in New York in order to distribute his brownies, cookies and pies more quickly to customers hungry for dessert.
But his company’s expansion was not without growing pains when Bush accepted two cash advances from merchants in 2019 to pay for the payroll and rent for the brick and mortar store he operated at the time.
“You are under a lot of pressure because you have people who depend on you. So you are in a very bad position and you are desperate, ”Bush said as he explored funding options. A broker directed him to the cash advance dealers even though he would have qualified for lower-cost options, Bush later said he learned.
The funds were delivered quickly but came with significant fees in addition to the financing rate that were not well disclosed, he said. He also felt misled about the interest rate originally offered, which was inconsistent with the company’s daily withdrawals from its accounts.
“There was no transparency at all,” said Bush.
De facto national standards
Soon, merchant cash advance companies as well as well-known fintech lenders like PayPal Inc. and Lending Club Corp. Urged by government agencies to provide far more transparency to small business borrowers.
Regulators in California and New York have proposed requirements for online lenders to disclose the cost of small business funding that borrowers apply for, such as: B. Interest Rates and Fees. Legislators in Connecticut, New Jersey, and North Carolina have made similar laws.
Once in place, possibly as early as January 1, 2022 in New York, state regulations could de facto create national standards that small business borrowers have waived due to a loophole in federal law.
Better disclosures and more transparency would help entrepreneurs avoid the funding that comes with the aggressive, expensive repayment that Bush saw once he took the advance.
“It will likely save a lot of small businesses,” he said.
Proponents of state regulatory efforts say the need for better disclosure is ripe as small businesses struggle to get back on their feet after the Covid-19 pandemic.
“The hope is that the standard can more easily get small businesses out of the hole they’re in and not fall back on loans they don’t fully understand,” said Armen Meyer, public policy director at the Lending Club.
The Responsible Business Lending Coalition estimates that small businesses could save $ 2.9 billion annually in California and $ 1.75 billion in New York. The group includes the online lenders Funding Circle and Lending Club, as well as community development and small business lenders.
As two of the largest markets in the US and number one on this issue, California and New York regulations will “set a benchmark for disclosure practices for all prospective borrowers,” said Jonathan Pompan, co-chair of Consumer Financial Services Practice from Venable LLP Group.
“At the federal level, there was a major focus on consumer borrowing rather than small business,” said Pompan. That leaves a void for many commercial borrowers, many of whom are individuals and minorities. “There is no such thing as a small business protection bureau,” he said.
Online lenders have become a major source of funding for many small businesses. They were the third most popular source of funding for small businesses over the past five years, according to a 2021 report by the Federal Reserve.
Medium to high credit risk business borrowers were more likely to turn to online lenders compared to low risk borrowers, the report said. Black-owned companies said credit availability would be their biggest challenge in the context of the pandemic, according to the report.
The Responsible Business Lending Coalition has been campaigning for the state governments for several years to bring more transparency to the market through standardized disclosures.
His vision is modeled on the Truth in Lending Act, a federal law that mandates the use of an annual percentage and other cost information on consumer credit. There is no similar federal law for small business borrowers.
“It creates information symmetry in the market for borrowers doing settlement deals, which then forces lenders to compete on price,” said Ryan Metcalf, US director of public policy and regulation at Funding Circle and coalition spokesman.
“That doesn’t happen today. There is no single metric for borrowers to compare products, terms and prices, and that annual percentage disclosure is the way to do it, ”Metcalf said.
Some financial services providers, including PayPal, Square Inc., and Stripe, as well as merchant cash advance companies fear their products could be real or perceived deprived depending on the disclosure metrics states want to introduce.
Financing products that are repaid at variable rates based on metrics like a dealer’s sales volume can be difficult to predict at the time of financing, companies say. An annual or monthly metric doesn’t exactly reflect the true cost of their funding, they say.
Others say the obligation to disclose both interest rates and fees in a single annual percentage rate disclosure would mislead borrowers about the cost of capital. Financial Innovation Now, a trading group that represents Amazon.com Inc., Intuit Inc. and Apple Inc. as well as PayPal, Square and Stripe, asked the California Department of Financial Protection and Innovation to allow companies to disclose tariffs and fees.
Otherwise, the APR disclosures “will have no relation to the true cost of borrowing” and could make comparison purchases “a confusing experience,” the group said.
Without provisions to accommodate their different business models, the California and New York Rules are not considered the national standard for any segment of the commercial lending industry, said Katherine Fisher, co-chair of the Business Funding Practice Group at Hudson Cook LLP.
“My hope is that state legislatures will not adopt the New York and California models all over the world, but will instead examine which disclosures are likely to be most accurate and helpful for small businesses,” she said.
The draft of the proposed New York Rules, released on September 21, would require disclosures for funding less than $ 2.5 million. It also provides methods for calculating financing costs and the APR. The disclosure requirements would take effect on January 1, 2022 under New York law.
California rules have taken more than a year to implement, but the lender community expects this state to finalize its own rules soon to keep up with New York.
Information would be required there for any funding less than $ 500,000. They also suggest requiring lenders to calculate and provide an APR or other metric to represent the cost of financing.
In the meantime, the Consumer Financial Protection Bureau is emerging as a potential actor in financial disclosure for small businesses.
Rohit Chopra, who was confirmed as CFPB’s new director earlier this month, is widely viewed as aggressively enforcing consumer credit laws and the agency’s extensive powers against unfair and fraudulent acts and practices.
As a Democratic member of the Federal Trade Commission, Chopra targeted online commercial lenders. As commissioner, he called on the FTC to “scrutinize” the marketing claims of certain cash loan providers by merchants who acted more like installment lenders subject to federal anti-discrimination laws and the Equal Credit Opportunity Act.
The CFPB is already developing ways to measure fairness in small business lending and has launched a data collection process to better understand financing terms for women and minority borrowers in small businesses.
“The open question then is what comes after and how this data is used by policymakers and the office itself,” said Venable’s Pompan.
The RBLC hopes that California and New York regulations will serve as models for possible CFPB requirements for small business credit disclosure.
“It’s a natural extension of what business borrowers should expect and what lenders should do,” Meyer said.