Nav’s CEO Levi King dropping knowledge at the AltLend conference.
Fresh off attending the inaugural AltLend℠ conference, Nav’s Founder and CEO Levi King serves up his thoughts on two of the the event’s most pressing topics: regulation and industry best practices.
Why is regulation a hot button now?
Well, it’s partly because the alternative lending sector is booming. These products have become very popular, very fast. And unlike consumer protection, only a few states have business lending requirements, so by and large it’s unregulated. From this perspective, the barrier of entry is low.
What’s concerning is as the sector as has grown, a few lenders with poor business practices have entered the space. These shady lenders can take advantage of small business owners who desperately need capital, but may not fully understand the costs involved.
If that abuse continues, and business owners complain, then the federal government will likely take notice and we may see regulations down the road.
“The challenge is to make loan disclosures more transparent, not to put a cap on interest rates, which may limit access to capital.
What are the potential areas of abuse?
Loan stacking: If any area of alternative lending should be cleaned up, the loan practice known as “stacking” would be a good place to start. Here’s how stacking works:
A lender does its underwriting due diligence and decides to give a business owner a loan. Once this is done, the lender submits a UCC filing on the business, which is public record.
From here, another lender can scan these UCC filings and contact the business owner. They offer to loan them an additional amount, but usually at higher rate, and stack this on top of the original loan. Lenders that do this really don’t have to do any underwriting on their own because they figure it’s been done by the original lender.
If a business owner isn’t doing the math, they could wind up spending 50% of cash flow trying to pay back multiple loans. Some lenders will even stack third or fourth loans on top. Not only does this put the original lender at risk, but can also sink some businesses.
Unclear loan terms and rates: I don’t believe in capping rates for business loans because it’s subjective, but it should be easier for the business owner to understand the true interest rate of a loan. For instance, a business owner may be quoted a 30% interest rate–but that’s only for 3 months. The true annual percentage yield on that is 120%.
Another popular, but sometimes difficult to understand, method is using a factor rate. With this, the business owner pays back a certain percentage of revenue to repay the loan.
For example, a business owner may borrow $50k for 4 months, and agree to pay it back at factor rate of 1.5. Most small business owners have no idea what that really means.
Essentially the borrower is agreeing to pay back $75k in four months with payments coming right out of checking account. If cash flow is already tight, can the business owner really afford to lose 30% of revenues on a daily basis?
What can be done to help?
To me, it’s about creating better, more transparent disclosures for the business owner. I don’t think there are necessarily “good” rates or “bad” interest rates, it’s subjective. But the terms and rates should be up front, easy to understand and calculate. That’s the real challenge.
When a business owner reads about a 1.2 factor rate, they likely have no idea what the hell this means. Terms like this should be clarified in the disclosures, so the costs involved are crystal clear.
Another way to remedy this may be by introducing a 3-day right of rescission. That way the business owner has 3 days to pay back one hundred percent of the loan and cancel the deal if they’re not comfortable with the terms.
How might regulation hurt business owners?
A point that can get lost in the conversation is the risk that regulators look at the commercial space and equate it with personal. The worry is they just put a cap on the amount of interest that can charged. But that doesn’t necessarily make sense because business isn’t a sum zero game like in the consumer space. We should be careful not to limit options for business owners.
For example, it makes sense that a consumer shouldn’t take a loan to buy a TV if the payments are going to bankrupt them. Generally, consumers have fixed income scenario, and it’s obvious when a loan is a bad idea.
But capping rates doesn’t really make sense for business owners, who may have many different revenue-generating scenarios.
For instance, a retailer may know about a hot toy for the holiday season they can buy for $1 and sell for $35. In that case, getting an advance with an interest rate of 50% makes sense. They have the potential to earn 30x on that money.
Ultimately, I believe business owners should have the right to call their own shots. If the terms are transparent and the business owner is aware of the risk involved–and they don’t succeed–then that bad decision’s on them.
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