As the Consumer Protection Agency places ever increasing restrictions on the payday loan industry aimed at individual consumers, the industry has been moving its focus to small and mid-sized distressed businesses.
Revitalization Partners recently spoke with a company that is a supplier to large aerospace companies that, in addition to a standard business bank loan, and a factoring loan, had three loans from East Coast based “alternative lending” companies. Let’s look at how these loans develop:
Same Collateral Secures Loans …
In this case, the loans, at extremely high interest rates were all secured by the same collateral. The collateral is future invoices of the company. Note that all of the loans are secured by the exact same collateral, making truly secured loans impossible.
The loans and interest were paid by having the funds extracted from the company’s bank account on a daily basis. As it became clear that the company could no longer make the payments, the owner of the company changed banks in violation of the loan agreements. Not being in a position to find their money, two of the lenders filed suit and obtained default judgements. How does a company owner find himself in such a position? To understand, it is important to look at how the industry works.
Is 134% APR Reasonable?
In an interview in 2014, Andrea Gellert of OnDeck, an alternative loan provider, responded to a question of whether it was reasonable to charge an APR of 134%.
“We think it is. APRs somewhat distort the true economic cost and cost-return relationship on the loan.” She said. “If I buy inventory for a dollar and sell that inventory for two dollars in a six-month period, that’s a 200% return. So my 54% cost [over the same period] makes absolute sense. I will make that trade-off every single time.”
The Next Business Crisis?
Are these predatory loans the next business crisis? Consider the case of the owner of a restaurant in Los Angeles. In looking for a loan to fund a remodeling project, he turned to an alternative lender for a $30,000 loan. The interest rate was 60% which resulted in a $6,000 per month payment. As that became a strain, he found out that he had no flexibility in the terms of the loan. His thinking, like many others who take out these loans was: “If I can just survive for a few months, I’ll be OK.” But, in all too many cases, that doesn’t happen.
A $35 Billion / Yr. Industry …
This industry of subprime business loans; the industry prefers to label them alternative: has grown to more than $35 billion per year. Some of the companies are very well funded, with OnDeck being backed by Google’s venture capital arm and PayPal co-founder Peter Thiel.
World Business Lending, formed by a former subprime mortgage lender, is becoming a big business. Bloomberg describes the business as follows:
“From an office near New York’s Times Square, people trained by a veteran of Jordan Belfort’s boiler room, call truckers, contractors and florists across the country, pitching loans with annual interest rates as high as 125%. When borrowers can’t pay, World Business Lenders, LLC. seizes their vehicles and assets, sometimes sending them into bankruptcy”.
As a result of the growing demand, loan brokers are popping up to help originate these loans. The lending companies pay brokers about $6,000 for the origination of a $50,000 loan.
Sales People with Prison Records…
Journalists who have investigated alternative lending industry companies have discovered sales people who have been removed from the securities industry and some who have prison records for mail and stock fraud. These sales people are trained to refer to “short-term capital” instead of loans and “money factors” instead of interest rates.
A financial spokesperson, highly critical of the industry pointed out that: “The sweet spot is someone who can limp along well enough for six months but probably isn’t going to be around much longer.” “These lenders are in the business of helping businesses fail.”
How Do You Avoid The Trap?
How does a business owner avoid falling into this trap? Most importantly, have someone knowledgeable in finance and debt that you can talk with before agreeing to ANYTHING that encumbers your business and/or personal assets.
If you don’t know who to talk with, your attorney or accountant can refer you to someone.
There is almost always a better alternative than a subprime alternative lender.
If your business is even slightly beginning to show signs of financial difficulty; ask for help. As a company that is in the business of assisting companies with business problems, our biggest complaint is that owners and managers wait until it’s almost too late to ask for assistance. And in some cases, as described in this blog, it is too late.
Bill Lawrence is our guest blogger this week. Bill is the Principal of Seattle-based Revitalization Partners, one of the top U.S. restructuring firms, working with all sizes of businesses to help solve complex operational and financial problems.