New Source of Business Loans Comes with No Regulation

Starting a small business is hard work.  And one of the toughest challenges is where to find the money you need to launch your business.

  • Using savings demonstrates that you have skin in the game – but it is very hard to save enough money to get to launch.
  • You may have support from family members, and that is great – but be sure everyone is clear about their expectations – miscommunication can lead to years of ugly Thanksgiving dinners!
  • Some businesses lend themselves to crowdfunding, particularly if they are artistic, fun or innovative in nature. But if these choices are not an option for you, where do you turn?

Many small business owners turn to credit cards.  And credit cards can be an important cash management tool for business operations.  They can help to smooth cash flow when payments lag behind the sale of goods or services.  But they are an expensive choice for longer term debt, like financing a piece of equipment or making leasehold improvements.

Consequently, many business owners seek loans.  And banks are eager to give business loans to established businesses with solid credit scores and some collateral to bring to the table.  If you fit in this category, your local bank branch should be your first stop.  They will provide you with the lowest cost capital.

However, many businesses and almost all startups will not be eligible for a bank loan.   So, you might start to look for other options on the internet – and WOW – will you ever find them!  This industry has exploded in recent years, fueled in large part by hedge funds for the high returns it offers.  But you need to be aware – there are very few regulations governing business lending practices.  The kinds of consumer protections we see in home mortgages and credit card lending are simply not part of the small business lending experience and you need to protect yourself.  Start with these three simple rules:

You should not accept any loan without knowing the following:

  • What is the Effective APR (Annual Percentage Rate) on your loan?  The effective APR includes the cost of fees and compound interest and most accurately reflects the true cost of the loan to you.  If your lender will not disclose this number and instead asks if you could afford a payment of $X per day – be very   If you take those daily payments and calculate the interest rate, you may find that it is more than double what you would pay on a credit card.
  • Ask what happens if you are suddenly able to pay the loan off ahead of schedule. Many of the loans from on line lenders can be structured in such a way that you enter into a contract to repay the loan and pay a large fee for the use of the money regardless of when you pay it back.  For example, a recent client came to us who had borrowed $20,000 and agreed to repay the $20,000 plus $15,000 in “fees” over the next six months.  His loan carried a 63% interest rate and he wanted to refinance, however, when he asked for a payoff amount, he was told it was the amount he had contracted for, regardless of his early repayment.  Don’t be fooled by asking if there is a pre-payment penalty and getting a “no” response – under the terms of these loans, this fee is not considered a “penalty” – rather, this is the amount you agreed to repay when you took the money, even if you don’t hold it for the full period.
  • Think about whether the repayment structure is right for your business. Many on line loans are structured to take repayment from your accounts daily.  That might work if you have the type of business that generates revenue daily like a restaurant or retail operation, but if you have a service business and get paid monthly, this repayment structure may leave you short of cash for daily operations.

So what is an entrepreneur to do?

Community Capital New York is a financing option for solid, sound businesses and business ideas that are not yet bankable, but want to avoid the high interest rates and other issues that can be part of an on-line loan.  Community Capital is part of a nationwide network of local, not for profit alternative lenders known as Community Development Financial Institutions (CDFIs) whose mission is to make capital available to small business owners.  We passionately believe that small businesses are the backbone of our communities – they create jobs, pay taxes, revitalize neighborhoods and create community stakeholders that enrich the lives of our communities and the residents who live there.  We are committed to being transparent and fair in our lending practices and we offer no cost, individualized support and training to help our business clients succeed.