Not Just Cookies, a growing online, wholesale bakery in Chicago. Johnathon Bush, founder of the company and passionate about baking, is opening new locations in Chicago and soon in New York to distribute his brownies, cookies and pies more quickly to customers hungry for desserts.

But expanding his business was not without challenges when in 2019, Bush accepted two cash advances to merchants to help cover payroll and pay rent for the physical store in which he operated. at the time.

“You are under enormous pressure because you have people who depend on you. So you are in a very bad situation and you are desperate “while exploring funding options, Bush said. A broker referred him to the traders cash advance companies even though he would have qualified for lower cost options, Bush said, he later learned.

The funds were delivered quickly but come with significant fees on top of the funding rate that were not well disclosed, he said. He also felt misled about the interest rate he was initially offered, which did not appear to match the amount of money the company was withdrawing from their accounts on a daily basis.

“There was no transparency at all,” said Bush.

National de facto standards

Soon, merchant cash advance companies as well as major fintech lenders like PayPal Inc. and Lending Club Corp. could be required by state authorities to provide much more transparency to small business borrowers.

Regulators in California and New York have proposed requirements for online lenders to disclose the cost of financing requested by small businesses, such as interest rates and fees. Lawmakers in Connecticut, New Jersey, and North Carolina have introduced similar legislation.

Once in place, potentially as early as January 1, 2022 in New York City, state rules could de facto create national standards without which small business borrowers have not been taken due to a loophole in federal law. .

Better disclosures and more transparency would help entrepreneurs avoid the financing that comes with the kind of aggressive and expensive repayment that Bush experienced as soon as he took the lead.

“It will probably save a lot of small businesses,” he said.

Recovery phase

Supporters of state regulatory efforts say the need for better disclosures is ripe as small businesses struggle to get back on their feet after the Covid-19 pandemic.

“The hope is that the standard can get small businesses out of the hole they found themselves in more easily and not fall back into loans they didn’t fully understand,” said Armen Meyer, head of public policy at Lending Club.

According to estimates by the Responsible Business Lending Coalition, state funding disclosure laws could save small businesses in California $ 2.9 billion and those in New York City $ 1.75 billion per year. year. The group includes online lenders Funding Circle and Lending Club, as well as community development lenders and small business organizations.

As two of the largest markets in the United States to act first on the issue, regulations in California and New York will “set a benchmark for disclosure practices for all potential borrowers,” said Jonathan Pompan, co-chair of the consumer financial services practice of Venable LLP. Group.

“At the federal level, the focus has been on consumer borrowing and not on small businesses,” Pompan said. This has left a void for many commercial borrowers, many of whom are individuals and minorities. “There is no small business protection office,” he said.

Online lenders have become an important source of funding for many small businesses. They were the third most common source of funding for small businesses over the past five years, according to a 2021 Federal Reserve report.

Commercial borrowers with medium or high credit risk were more likely to turn to online lenders for financing than low-risk borrowers, according to the report. Black-owned businesses have said availability of credit will be their toughest challenge coming out of the pandemic, according to the report.

The Responsible Business Lending Coalition has been lobbying state governments for several years to bring more transparency to the market through standardized disclosures.

His vision is modeled on the Truth in Lending Act, a federal law that requires the use of an annual percentage rate and other cost disclosures for consumer loans. No similar federal law exists for small business borrowers.

“This creates a symmetry of market information for borrowers to compare, which in turn forces lenders to compete on price,” said Ryan Metcalf, head of public policy and regulatory affairs at Funding Circle in the United States. and spokesperson for the coalition.

“Today, that does not exist. There is no single metric that allows borrowers to compare products, terms and prices, and these disclosures using the annual percentage rate are the way to do it, ”said Metcalf.

Precise aspect?

Some funding providers, including PayPal, Square Inc. and Stripe, as well as merchant cash advance companies, fear their products may be at a disadvantage, real or perceived, depending on the disclosure measures states wish to put in place. square.

Finance products that are repaid at variable rates, based on metrics such as a merchant’s sales volume, can be difficult to predict at the time of finance, according to companies. An annual or monthly measurement does not accurately reflect the true cost of funding them, they say.

Others say that a requirement to express both interest rates and fees in a single APR disclosure would mislead borrowers about the cost of capital. Financial Innovation Now, a trade group representing Amazon.com Inc., Intuit Inc. and Apple Inc., as well as PayPal, Square and Stripe, has asked the California Department of Financial Protection and Innovation to allow companies to disclose rates and charges separately.

Otherwise, the TAP’s disclosures “will have nothing to do with the actual cost of credit” and could make price comparisons “a confusing experience,” the group said.

Without provisions that take into account their different business models, the California and New York rules will not be considered a national standard for a segment of the commercial lending industry, said Katherine Fisher, co-chair of the corporate finance practice group. by Hudson Cook LLP.

“I hope state legislatures do not broadly adopt the New York and California models, and instead consider which disclosures are likely to be the most accurate and useful for small businesses,” he said. she declared.

State provisions

New York’s proposed regulation, released on September 21, would require disclosure of funding under $ 2.5 million. It also provides methods for calculating finance charges and the APR. The disclosure requirements would come into effect on January 1, 2022, under New York law.

California rules have taken over a year to implement, but the lending community expects that state to put in place its own regulations soon to keep pace with New York.

Disclosures would be required for any funding less than $ 500,000. They also propose to require lenders to calculate and provide an APR or other metrics to display financing costs.

Federal efforts

Meanwhile, the Consumer Financial Protection Bureau is emerging as a potential player in the disclosure of small business financing.

Rohit Chopra, who was confirmed as the new CFPB director earlier this month, is widely seen as an aggressive enforcer of consumer loan laws and the Dodd-Frank Act’s broad powers against unfair and deceptive acts and practices.

Chopra has targeted online commercial lenders as a Democratic member of the Federal Trade Commission. As commissioner, he called on the FTC to “take a close look” at the marketing allegations of certain merchant cash advance providers who function more as installment lenders, who are subject to federal anti-discrimination laws and the United States. Equal Credit Opportunity Act.

The CFPB is already developing ways to measure the equity of small business loans and has embarked on a data collection effort to better understand the financing terms women and minority small business borrowers receive.

“The open question then is what is the next step and how this data will be used by policy makers and the office itself,” Pompan de Venable said.

The RBLC hopes the California and New York regulations will be models for possible CFPB requirements on small business loan disclosures.

“It’s a natural extension of what commercial borrowers should expect and what lenders should do,” Meyer said.