The “ Great Recession” of 2008 had a lingering effect on how banks lend money to small business owners and entrepreneurs. Gone are the days when small businesses had fast access to bank credit at competitive interest rates. Instead, alternative non-bank lenders led by companies such as On Deck, Yellowstone, and Cash King are filling the lending void, growing rapidly on the backs of unwary small-business owners.
Here are five things small business owners should consider before taking out an “alternative” business loan.
High Rates Not Federally Regulated
High-rate loans are the rule rather than the exception for alternative lending sources. These lenders are not banks and therefore are not federally regulated, unlike companies that provide loans to consumers. Instead, these loans are often funded by private investors selling credit at effective annual rates that commonly exceed 30%.
Non-cancellable Daily Payments
Since alternative business lenders don’t look at individual or business credit ratings, their risk of not getting paid back is high. They rely on a business’s cash flow only and expect to be paid daily rather than monthly by using a non-cancellable automatic payment deduction (“ACH”) out of the borrower’s account. The lender can immediately call a loan in default should a business owner fail to replenish their designated account. This exposes the borrower to litigation and further expenses. Borrowers should be confident that they can meet their daily, rather than monthly, obligations.
Expensive Arbitration Clauses
Alternative loan contracts generally have expensive arbitration clauses, where the debtor agrees to forgo the traditional legal process for a binding decision from designated arbitrators. Arbitration clauses are not favorable to borrowers. They often dictate where a legal case can be heard, usually in a creditor-friendly state far removed from the borrower. This creates added expenses for a case even before it’s heard on the merits. Arbitration decisions usually cannot be appealed (binding arbitration). Finally, professional arbitrators have been criticized for having biases in favor of lenders, since successful arbitrators make their living from work referred to them by the lending industry.
Disturbing Consent Judgments
Many lenders have business borrowers essentially endorse a “consent judgment” before the ink is even dry on the original lending agreement. In a consent judgment, the borrower admits to a default and to the terms of a judgment against them, waiving any legal protections that they might otherwise have. Lenders will say that this instrument is harmless and only used if there is an actual default. It’s a disturbing trend because it sets the borrower up for failure and legally neutralizes them. (Imagine a hospital locating a hamburger stand next to the cardiac care unit or meeting a bank’s REO bank officer right after you close on the purchase of your home.)
Personal Guarantees on Business Loan
While the business loan is given to the business in name, the small business owner often personally guarantees the payments if their business fails. Personal loan guarantees are an integral part of the lending agreement, so borrowers should think carefully before signing. Lenders will look to the former business owner to make payments long after a business closes its doors.
Small Business Assistance
Alternative business loans appeal to business owners because the loan process is much faster than traditional lending sources. Some lenders say a loan approval can be given in less than 48 hours, and there are no personal credit requirements. If you don’t need the money “yesterday” (these types of lenders anticipate that you do), then you should seek assistance through a nonprofit dedicated to helping business owners in all areas of business and finance, an SBA lender (Small Business Administration), or the assistance of a knowledgeable business attorney who can help you negotiate a far better loan agreement.
About David Soble: David is a seasoned real estate and finance attorney with more than 35 years of experience, combining his background as a “big bank insider” with a commitment to demystifying complex legal issues for his clients. As the founding attorney of Soble Law (also known as Soble PLC / Proven Resource), he leads a specialized team in Michigan and Ohio that handles real estate transactions, contract disputes, probate, and financial litigation. Known for a practical, no-nonsense approach and peer-rated excellence (Martindale-Hubbell AV Preeminent), Soble and his team strive to protect clients’ property and financial interests with clarity, integrity, and experience.
Disclaimer: You should not rely or act upon the contents of this article without seeking advice from your own qualified attorney.
