Since traditional banks have largely stopped making small business loans, an influx of companies are stepping in to fill the gap. While some are lending to small businesses in a responsible way, many are not.
By signing Senate Bill 197, Gov. Jerry Brown took one small step to making sure that small business lending is not predatory for California’s entrepreneurs.
To illustrate the problem, look to Catarah Hampshire and Shoneji Robison. They quickly grew Southern Girl Desserts, a cupcake business in Los Angeles. To keep up with demand and to expand, they needed fast cash to purchase equipment. A loan broker quickly got the “dessert divas” a cash advance and additional financing from an alternative lender.
Because both loans had very short terms and very high interest rates, Hampshire and Robison were unable to keep up with the large daily loan payments. Short of cash, they soon took out two more cash advances. The advances are not loans, are not regulated and can carry effective annual interest rates of 15 percent to 80 percent. Added up, their financing costs were eating up 40 percent of sales.
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Then Hampshire received a flier in the mail from Opportunity Fund, a nonprofit microlender that offered a chance to refinance predatory loans with affordable capital. Her business cut their monthly payments by 90 percent with a longer term and lower interest rate. This loan also helps them build their credit, since it is a regulated business loan, not a cash advance unreported to the credit bureaus.
Opportunity Fund and other responsible lenders make sure that businesses have the ability to repay before making loans – an old-fashioned process called underwriting. Responsible lenders also do not make a second, third or fourth loan to a business already drowning in debt. SB 197 will help responsible lenders become more competitive with other financiers, such as cash-advance firms.
The measure is crucial to California’s 3.6 million small businesses and microbusinesses, which need better information about the most appropriate financing available to them. Word of mouth is key to reaching business owners, especially in immigrant and minority communities.
Referral fees for successful loans encourage word of mouth, but before SB 197, state law prohibited licensed lenders from paying such fees to individuals or small businesses that do not have a state broker’s license. Most referrers – including tax preparers, nonprofits and others – are not licensed because of high costs.
Meanwhile, alternative lenders and banks commonly use brokers to reach potential customers. Also, since they structure their products so they are not loans, they can pay referral fees to anyone.
Because of this uneven playing field, California businesses were not always getting the best financing available. With SB 197, Opportunity Fund and other lenders can now compete against predatory lenders. It is still a bit like David vs. Goliath trying to reach small-business owners with the affordable credit, but SB 197 provides responsible lenders with a new slingshot.
Claudia Viek is CEO of the California Association for Micro Enterprise Opportunity, a statewide network of microlenders. Eric Weaver is founder and CEO of Opportunity Fund, a leading microfinance provider.