Not that long ago, there was a lot of noise and some clarity about the concept of crowdfunding, which is using technology to aggregate the funds of donors/lenders/investors for a specific recipient/business.
During that period, I tried to be part of the clarity by writing several articles about the three different kinds of crowdfunding, which are: contribution fundraising, business lending, and investment acquisition. Today I want to revisit the lending model, with some new information.
Crowdfunding lending is like the traditional kind in that a request for funds comes with the promise of repayment with interest over a specific term. Proceeds for a bank loan come from depositors; with crowdfunding, the cash typically comes from investors. But unlike a bank loan, crowdfunding lending is conducted almost exclusively online. Individuals use crowdfunding loans, but our focus here is on business borrowing.
It’s important to report that the term crowdfunding is now more widely referred to as FinTech, because the interface process, from borrower introduction and debt service, to return of capital for investors is conducted on a digital platform. At the heart of my purpose here is that regardless of the funding source – crowdfunding or traditional – interest and terms on small business loans are always higher and tighter than for any other business sector. Almost by definition, a small business loan is a high-risk decision, for two primary reasons:
- Most small businesses are undercapitalized and operate closer to closing than surviving.
- Too many small business owners don’t track financial performance well enough to know where they are on that survival/closing continuum.
In the past, my standard advice to any small business owner is to try to get a loan with a local, planted-in-the-ground, financial institution, because regardless of the rate and terms, they were always the most reasonable of all options. With a FinTech loan, the interest rate is likely to be double-digits, as in 15%, or more. As cool and sexy as digital can be, there’s nothing sexy about paying more for a loan than necessary.
So, the only reason to use a FinTech lender is if you’re unable to get a traditional loan. That’s called “being unbankable.” It’s associated with creditworthiness, which could be a low credit score, lack of collateral, unproven business model, poor cash flow, or some combination thereof. Frankly, when those examples apply, the business is likely in some level of financial desperation, and we all know what desperate people do. They do desperate things, like paying double-digit interest just to try to keep a business alive.
But since crowdfunding morphed into FinTech, another online funding option has materialized: the Merchant Cash Advance (MCA) sources. These are not lenders in the traditional sense, like your bank or true FinTech lenders. The distinction is in how their contract to provide funds is worded – they call the transaction a purchase of future receivables, not a loan.
This detail is important to note because lenders – crowdfunding/FinTech and banks – must comply with state usury laws, which put a ceiling on the annual percentage rate of the interest on the loan. But as they structure their funding relationship, a typical MCA company may operate outside of usury, which in some cases produces an APR well over 50%. Here’s some tough love: You will not work your way out of an MCA transaction because of:
- How they withdraw payment from your bank account – not monthly, but possibly every day.
- The fees and interest they charge can be over 50%.
- Their contracts include “confession of judgment” language that puts you at an extreme legal disadvantage the moment you take their money.
So, if you’re bankable, borrow from a bank or credit union. If you aren’t, the more lenient underwriting standards of FinTech firms could be the right option. Even at the very expensive FinTech rates, you could work your way out of a desperate condition if you have a viable and sustainable business model.
But here’s more tough love: If you find your only option is to pursue funds from an MCA source, the next step is not complicated, but it is anguishing: Go ahead and lock the doors of your business – for good. In the end, it will be less painful.
One last bit of hope for the unbankable: Ask your banker about help with an SBA loan. Just say this: “How about an SBA loan.” I got one once.
Write this on a rock … Discovering which borrowing level you qualify for simultaneously locates your business on the surviving/closing continuum. However rude that indicator may be, it’s just as immutably pure.