Loan Brokers’ Business Model
Business loan brokers’ make money by helping business owners obtain business loans. They usually get commission as a percentage of the loan amount paid by the lender. For example, if a broker successfully broker a $50K loan for which the lender pays the broker 5%. The broker will receive $2,500 after the deal is closed. It’s a very simple business that boils down to the two following metrics:
- Customer Acquisition Cost (CAC) is the marketing cost loan brokers spend to find a new customer.
- Lifetime Value (LTV) is the life time revenue the broker can earn from the acquired customer.
Like all other businesses, loan brokers are in business to minimize their CAC and maximize LTV.
Why The Incentive Is Misaligned
Business loan brokers usually purchase qualified leads through various sources. For example, a loan broker can purchase qualified leads for $10 per lead and convert 10% of the leads to an actual closed loan. This will make CAC $100 dollars. To minimize CAC, loan brokers are incentivized to push loans to a high percentage of business owners to maximize the conversion rate. This creates a perverse incentive for loan brokers to recommend loans to business owners who probably shouldn’t get a loan. For example, it’s probably not a good idea to give a startup whose founders have no prior industry experience a big loan, say $100,000. But if such a startup loan product exists, loan brokers will most likely recommend it to business owners because that helps them make a sale.
Due to the transactional nature of business loans, most loan brokers treat the commission from the current transaction as their LTV. To minimize LTV, loan brokers would push for loan products that are most profitable to them rather than products that are best for business owners. For example, if a business is qualified for two $100,000 3-yr business term loans: one with 15% APR and the other with 25% APR. The loan brokers should certainly obtain the 15% APR loan for the business owner. But if the 25% APR lender pays twice the commission, most loan brokers will be tempted to obtain the 25% APR loan for the customer instead. This is what’s happening in the marketplace right now. Understandably and unfortunately, loan brokers are not acting on behalf of the interest of business owners if their interest is conflicting with the business owners’.
Are There Good Brokers Around?
You might wonder if there are good business loan brokers around who will act on behalf of business owners’ interest and put their own interest a lower priority. It’s possible but it’s really hard to verify. I would be skeptical of loan brokers who claim that without any clear proof. Their incentive system makes it a very slippery slope to optimize for their own profit and put business owners’ interest onto the back burner.
In addition, it’s expensive to acquire business owners for a loan these days. It can cost thousands to acquire a business owner and a loan broker probably only gets a handful of deals done per month. They have to make enough money to support themselves. They are not going to starve themselves for the interest of business owners.
What Business Owners Should Do
We aim to help business owners understand the business financing landscape and do due diligence on individual lenders. Obtaining a business loan is a big decision and the lifetime cost for a loan is usually tens of thousands of dollars. It’s worth spending time to really understand what you are getting into. Even if you decide to go with a loan broker after all, make sure you do the due diligence to avoid suboptimal recommendations from a broker.
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