“He that by usury and unjust gain increaseth his substance, he shall gather it for him that will pity the poor.” – Proverbs 28:7-9
Last week we wrote about the opportunity for entrepreneurs and small business owners to obtain debt financing in order to fund business operations and growth. Our primary focus was on the Small Business Administration’s loan guarantee program, which provides credit support and thereby enables qualifying small businesses to borrow from commercial banks at very reasonable interest rates. Click here to read the full post.
This week is a more cautionary note about the current lending market for small businesses.
You really have to be very careful when it comes to small business loans – particularly if you are looking at options beyond the traditional SBA loan guarantee program.
In the last few years there has been a proliferation of firms and alternative funding providers entering into the market, oftentimes making small business owners all sorts of incredible sounding promises about how they can instantly qualify for credit on a no document or doc-lite basis. I’m sure many of you are very familiar with these sorts of offers from the steady barrage of emails, at least some of which manage to get through the spam filter.
What’s going on here? Who are the lenders making these kinds of offers and do these solicitations really represent a realistic financing option that a small business owner should consider?
The small business lending market is beginning to operate on a basis similar to the home mortgage market in the years immediately prior to 2008. As some market observers describe it, it’s like the Wild West. The small business lending market is a market that is operating with only minimal regulatory oversight as a flood of new players come in looking to make a fast buck.
Small business owners should relegate these emails directly to the spam folder.
Ordinarily, the business loan market is not quite so freewheeling because banks lenders themselves are subject to substantial state or federal regulation. Many of the new players coming into the small business loan market are not traditional banks. They are instead alternative funding providers that are not subject to any sort of regulatory oversight. Moreover, very often these companies will propose to advance your company funds in the form of an advance against future receivables so it is technically not a loan at all but rather a forward purchase agreement. These arrangements are not subject to usury laws, since they are not structured as loans, which means your company can end up paying an effective interest rates of 50% or 60% or even higher for a cash advance, as compared to the low-interest rates available through the traditional SBA loan guarantee program.
If something sounds too good to be true that’s most likely because it is. In the case of the small business financing, don’t let yourself get fooled by promises of quick funding for your business no matter what your credit history may be. If you decide to explore debt-financing options for your small business, you need to proceed with extreme caution, particularly if you decide to look beyond the traditional option for bank loans made pursuant to the SBA loan guarantee program.
If you have questions, please feel free to give us a call or send us an email.