Alternative lenders that cater to small businesses are a booming industry. Companies such as OnDeck and CAN Capital have attracted hundreds of millions of dollars in venture capital and doled out billions to Main Street merchants. With the help of
Silicon Valley backers such as Google Ventures and Accel Partners, they’ve built reputations as technology-driven firms whose vaunted algorithms use
social media profiles and other unconventional data to get money to small business owners that banks consider too risky.
But behind the
high-tech gloss, alternative lenders rely on an old-fashioned method to find borrowers: loan brokers. These independent agents funnel cash-strapped business owners to dozens of companies that fund merchant cash advances and other high-cost loans. And their sky-high commissions, usually hidden from merchants, can double the cost of already expensive loans, according to industry insiders and documents describing commission structures obtained by
Bloomberg Businessweek.
In one example, a business borrowing $50,000 over six months could repay $65,500, with more than half the effective interest going to the broker. The commission of 17 percent far outstrips the 1 percent or 2 percent brokers earn on
loans backed by the Small Business Administration.
Some observers and executives in the industry worry that brokers are steering costly loans to small businesses that can’t afford them. “It’s a direct parallel to what happened in the subprime mortgage space,” says Mark Pinsky, chief executive officer of
Opportunity Finance Network, an umbrella group for community lenders that make more affordable business loans. “Things got out of control because of the incentives to brokers who had no skin in the game.” Jeremy Brown, CEO of Bethesda (Md.)-based lender RapidAdvance, says that high commissions
remind him of the previous decade’s lending frenzy: “The brokers are getting outsized influence again.”
About two dozen alternative lenders provided roughly $3 billion to small businesses last year, estimates Marc Glazer, CEO of Business Financial Services, an alternative lender based in Coral Springs, Fla. The loans, typically for less than $100,000 and lasting less than a year, are marketed as easy to get for businesses that don’t qualify for bank loans or don’t want to jump through the hoops of applying. Many alternative lenders sell products called merchant cash advances. In those arrangements, lenders advance a lump sum and collect payments automatically, by diverting a daily cut of the merchant’s credit card sales.
It’s a lucrative business—some loans can carry effective interest rates that, on an annual basis, would reach into the triple digits, though effective APRs around 30 percent are more common. But finding borrowers can be tricky. Alternative lenders lean heavily on online ads, but that’s expensive and doesn’t guarantee customers, says Kris Roglieri, CEO of Albany (N.Y.)-based Commercial Capital Training Group, which trains would-be brokers. By paying brokers only when they close a deal, lenders can make their marketing costs more predictable, Roglieri says. His weeklong course, which he calls a “business in a box,” costs more than $23,000.
As alternative lenders grow bigger and have more money to put to work—some have gotten credit lines from Wall Street firms including Goldman Sachs and Fortress Investment Group—competition for borrowers is increasing. That’s led to bigger incentives for brokers. “The new battlefield for funders is over who can offer brokers the most dynamic commission package,” says Jay Ballentine, co-founder of New York-based startup Buynance, a website that aims to match lenders and borrowers at a lower cost. Ballentine says brokers, in addition to charging hefty commissions, sometimes demand closing fees of as much as $5,000 that borrowers don’t learn about until they’re ready to sign a contract.
Brokers’ agreements with lenders show how much more the middlemen can add to the cost of a loan.
Bloomberg Businessweek obtained a 2013 broker agreement used by a
CAN subsidiary that shows the lender expects to be repaid 14 percent above the amount it advances on a six-month term. But its most preferred brokers can tack on an additional 17 percent, making the total cost to the borrower 31 percent of the loan. On a $50,000 loan under those terms, a small business owner would pay back $65,500, with the independent broker receiving more than half of the effective interest.
CAN, which is backed by venture investors including Accel Partners, declined to make executives available for an interview or comment directly on the size of broker commissions. In an e-mailed statement, the company said it uses “a variety of marketing channels and commission structures” and that charges depend on “our proprietary scoring model and the history of that particular company.”
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