The “ Great Recession” in 2008 had a lingering effect on how banks lend money to small business owners and entrepreneurs. Gone are the days when small businesses have 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:
- Rates That Make Former Subprime Mortgage Lenders Blush. 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 ACH’s. 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.
- Arbitration. 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 to 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.
- 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. Lender’s 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. 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.
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 type of lenders anticipate that you do), then one should seek assistance through a non-profit 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 the Author:
Since 1990, David Soble has represented lenders, loan servicers, consumers and business owners on residential and commercial real estate, finance and contract issues. He has been involved in thousands of real estate transactions and has been responsible for billions in real estate loan portfolios throughout his career.