Last week, the Consumer Financial Protection Bureau (CFPB) filled the new position of Assistant Director for Office of Small Business Lending. After signaling for months that they’ve been looking at the small business space, this move likely means that regulations are coming down the pike.
To explain what this means for small business owners and lenders, Nav’s co-founders, Levi King and Caton Hanson, serve up their thoughts.
Why is a consumer oversight agency focused on business lending?
Levi: Well, first you have to take into account the rapid rise of the alternative lending sector. The popularity of these products has just shot through the roof. And unlike with consumer protection, for the most part it’s unregulated. There’s not a high standard for who can set up as a lender. This has inevitably led to a few bad apples—shady people with poor business practices taking advantage of small business owners who are desperate for capital but either don’t understand the costs involved or take crazy risks that a responsible lender wouldn’t have given them as an option in the first place.
Caton: I think you also have to delineate between a small business owner who looks like a consumer and a small business owner who’s well-established. It’s the first group that’s getting taken advantage of: new businesses, sole proprietorships, unprofitable businesses.
Their ability to provide for their family is on the line, and they’re likely less savvy, asking themselves, “Do I make another payment on this loan whose interest rates are eating me alive, or do I put food on the table this month?” There’s a big difference between that small business owner and the one who’s making millions a year in revenues. One’s really vulnerable to this sort of abuse and the other isn’t.
Levi: And as the abuse continues, and more and more small business owners stand up in protest, that’s when you see the government step in. As to why it’s the CFPB doing it, they’re clearly defining small business owners in this scenario as consumers. The little guy getting taken advantage of.
Are there already existing small business regulations?
Caton: Yeah, but they’re not really enforced. For example, say you apply for business insurance and get charged a higher rate or denied altogether because negative data in your business credit report has lowered your business credit score. Under the Equal Credit Opportunity Act (ECOA), they should notify you as to why they’re taking adverse action.
Levi: If there’s anything negative in your data that’s impacting your credit data anywhere—that’s impacting the lowest cost of any type of financing, good, or service—there needs to be notification. All too often, there isn’t with business credit. You can’t fix a problem if you’re not made aware of it.
Caton: With businesses, there are circumstances where the ones taking adverse action are allowed to do it orally. It doesn’t have to be in writing. And it doesn’t have to be after the adverse action, it can be prior to it. You can imagine how people get really creative with that. We need to close those loopholes, maybe by applying consumer rules to adverse action notices for both the FCRA and the ECOA.
Would introducing regulations to support small business owners be a good thing?
Levi: Yeah, for sure. We support smart regulation. Whether we ultimately end up agreeing with the CFPB’s approach or not, we agree that there should be consumer protection in small business. For example, we think that the FCRA should cover small business credit. We think these protections should extend to the black box of business insurance underwriting and to every other type of risk-underwriting for small businesses. The bottom line for us is that small business owners should have rights and protections like you do in consumer finance. There needs to be transparency and standardization.
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Caton: There’s already precedent for this sort of thing—applying consumer protection laws to businesses—because some actually do apply, like I mentioned earlier with the ECOA. There are looser requirements for business credit applications than there are for personal credit applications, but they’re still the same requirements in general—there’s still that protection of understanding what’s going on, what are your rights, and what are the liabilities involved.
So many small business owners are really consumers—sole proprietors or one-employee businesses, for example. They’re acting in a consumer role. But however it gets done, there should be way more transparency. If your credit gets dinged because of a late payment report by a vendor, you should know who it is. Is this a Home Depot account, is this an American Express account? Right now, business credit reports don’t specify which company is reporting information on you. It’s just listed as a trade line.
Levi: And you should be able to dispute it if it’s wrong.
Caton: Absolutely, there should be a formalized investigation process. You can dispute business credit report errors, but there are no hard and fast rules for when the bureaus have to respond, unlike with personal credit, which is covered by the FCRA. The real issue here is disclosure and transparency. Small business owners should have the right to be aware of what’s going on.
The real issue here is disclosure and transparency. Small business owners should have the right to be aware of what’s going on.
What are some potential dangers of regulation?
Levi: Well, alternative lending space is on an amazing tear—FinTech in general is on an amazing tear. Figuring out how to extend capital to more and more people in more and more scenarios, whether it’s industry, stage of life, or credit, is a good thing. Let’s not ruin that, let’s not stifle that, let’s not stop that. Let’s not make it too burdensome to do business. If a legitimate FinTech business is focusing on regulations and paperwork and licenses, if half their money’s spent satisfying government regulations, it won’t be in business long. And that means less resources for business owners looking to access capital.
Caton: And again, the CFPB should delineate between a consumer-type small business and a savvier, more established, successful one. Who knows what that actual mark is—maybe it’s a million a year in revenues, maybe it’s five million. But once you get to a certain point, I would be a little less excited about regulation. You really want to focus on the small business owner who doesn’t understand as much.
Levi: I wouldn’t tie it into revenues as an industry, necessarily—I’d tie it into profitability, time in business and number of employees. I mean, if you have fifty employees, $500,000 in profit, and you’ve been in business for ten years, you don’t need a bunch of protections. The people we’re most concerned about are the ones who are vulnerable. Startups, unprofitable businesses, people who are newer to business, 1099ers, etc. We’re worried that if the CFPB treats small businesspeople in general as consumers—if they imposed usury laws, for example—it could wipe out legitimate financing in lots of scenarios that are very important.
Caton: It’s also important to note that there are examples of the kind of stifling regulations that Levi mentioned already occurring—California’s an example. It would be helpful if the CFPB would research how regulation is affecting the alternative lending space there, rather than just start from scratch. If Nav can’t help someone get a loan in California because of this sort of wholesale rulemaking, how’s it going to affect small business if the same standards are applied nationally?
Levi: Look at it this way. It’s never smart for a consumer to finance a big screen TV at 50% interest. It makes sense to have a usury law against 50% financing to some guy who just wants to relax and watch his favorite football team in HD, but has a limited income and clearly can’t afford it. On the other hand, I could give you a hundred scenarios where it makes all the sense in the world for a business owner to borrow money at 50% APR. Whether it’s to complete a project, turn inventory, win a contract, whatever. Caton and I, in our business past, have used all sorts of financing—sometimes very expensive financing—that made sense in the situation, and we have no regrets in hindsight. The biggest potential danger of regulation as the CFPB moves forward is that it hurts access to capital and stifles innovation.
What are ways Nav would like to see regulation bring transparency to lending and credit?
Caton: Applying the FCRA across the board for business credit would be a start. You’re already using a lot of consumer information on a business report. And close the loopholes that allow a business insurance company to take actions that would be illegal in private insurance. Enforce the laws that are already on the books, in other words, before you begin implementing a bunch of new ones.
Levi: We need to address the problem of people getting trapped in financing—that’s a major problem. It’s a must that lenders be able to document, if they ever get audited, that they did a cash flow analysis to make sure that you could actually afford to repay the loan. Look, as a company we’re agnostic as to whether the cost of financing is morally right or wrong. But we take a very hard stance, ethically and morally, when it comes to business and sales practices and transparency disclosures. How do you sell, how do you sign and renew a contract? Any process used to deploy capital to small business should be as transparent to the debtor as it is the creditor.
Caton: The introduction of the Borrower’s Bill of Rights, which we signed, is a step in the right direction. The Coalition for Responsible Business Finance and Marketplace Lending Association are others. It’s great to see responsible lenders like Prosper, Lending Club, Funding Circle, Fundation, and others proactively take a stance against these problems and push for reform from within the industry, rather than having it imposed by the feds. The more transparent you are, the more you police your own community, the less need for outside intervention.
Levi: We’re very supportive of efforts like these. I agree that they’re steps in the right direction, but they’re far from complete. At the end of the day, the lenders taking action are still self-interested—if you’re a balance-sheet lender, you’re going to want to skew things in your favor. If you’re a term loan provider, you’re going to call out merchant cash advances for charging high rates. There’s nothing wrong with it necessarily, but be open about the way you do it. Nav kind of has an interesting position in this argument, because we can say without qualification that there’s nothing adversarial in our relationship with our customers. The only way we make money is by giving them honest advice on what their best options are. Our business model is advocacy—we fail if we don’t stay true to it.
The only way we make money is by giving them honest advice on what their best options are. Our business model is advocacy—we fail if we don’t stay true to it.
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