On February 26, 2020, the Federal Trade Commission (“FTC”) Bureau of Consumer Protection released a staff perspective (“Perspective”) on consumer protection issues related to small business financing. Based on information presented at the FTC’s “Strictly Business” Forum (“Forum”) held in May 2019, the Perspective discusses trends in small business lending, including the emergence of new online options available to businesses, and potential benefits and consumer protection concerns.
According to the Perspective, small businesses often face significant challenges to obtain financing, which is typically for relatively small amounts (often $250,000 or less). The Perspective notes that while many small enterprises can and do obtain loans from traditional lenders, other businesses may not qualify for such loans. As a result, small businesses have increasingly turned to relatively new online providers offering loans, lines of credit, and other products.
Rise in Online Lending and New Players
Small businesses are increasingly turning to online lenders. The Perspective cites a survey by several Federal Reserve Banks that found that in 2018, 32% of small businesses reported applying for online financing — up from 24% in 2017 and 19% in 2016. According to the Perspective, online financing products have a broad range of features that vary from product to product. While some online lenders offer loans or credit agreements that resemble traditional bank loans or lines of credit that accrue interest and require monthly payments over a set term length, others charge consumers flat fees and may require weekly or daily repayments. Also, some alternative products do not offer the advantage of early payoff.
The Perspective also notes that many online lenders are new to the market and often base their underwriting on non-traditional sources including financial technologies and alternative data. Among these new entrants are payment processors and technology platforms, which often leverage the information they already collect from small businesses ( including credit card receipts or sales information) to offer financing products. Additional new entrants include nonprofit “microlenders” that rely on fintech, such as crowd funding, to attempt to offer affordable loans to underserved borrowers.
According to the Perspective, many online providers cater to higher-risk businesses or owners with low credit scores and typically offer them higher-cost products. One such product, “merchant cash advances” (“MCA”), seems especially concerning to the FTC. With an MCA, the provider buys a fixed portion of a business’ future credit card or debit card sales receivables. In exchange, the business must repay, often on a daily basis, the advanced amount plus a factor of that amount — often between 20% and 50% of the advance.
Potential Benefits and Risks of Online Financing
The Perspective identified potential benefits and risks of online financing that were discussed at the Forum. Among the potential benefits are: speed and convenience, broadening access to credit, and flexible financing amounts, terms and repayment options. Forum participants also expressed a number of concerns about how some products are being offered in the evolving marketplace (including the use of aggressive, potentially misleading sales tactics and abusive collection practices).
The Perspective also reflects the concern that inconsistent information and non-uniform disclosures could impede the ability of business owners to make “apples-to-apples” comparisons of their options for financing. According to the Perspective, small business owners often are confused about the central features of financing products, and underestimate the costs of the products.
Because of the possibility of consumer confusion in the small business financing marketplace, providers should keep in mind the FTC Act’s prohibition against deceptive and misleading claims as they are designing and marketing their products. According to the Perspective, small business owners’ understanding of financial products may be more akin to that of individual consumers in personal credit transactions. Further, the Perspective warns that providers should avoid the types of practices that the FTC has alleged to be deceptive in enforcement actions involving small business and individual consumer financing. Such actions have included allegations of deceptive fees, consumer savings, payment amounts and/or interest rates.