A new predatory lending scheme is targeting struggling small business owners.
Sadly, just like the old loan sharks in the movies, many small business owners have fallen victim to these predators, and it has cost them their business and sometimes personal bankruptcy.
Everyone understands that bank loans are more difficult than ever to obtain for a small business owner. Whether you blame it on too much regulatory control, like Dodd-Frank mandates, stingy bankers or an anemic economy, if you need funds to grow your small business, it can be a very steep hill to climb.
A fact of entrepreneurial life is that your startup capital usually comes from your savings, your friends’ savings, your family members’ savings and a bunch of credit cards. But even when you are profitable, you need money to grow your business.
When your credit cards and family are maxed out, yet you can prove you have a viable business, where can you go to get money to finance growth?
As stated earlier, for whatever reason, bankers are loath to lend to a small business owner unless there are at least 2 or preferably 3 years of tax returns showing a continually increasing profit. And that profit has to be more than enough to make the loan payment while continuing to pay the staff and owner and build equity. They will not “bet on the come line” with you that you are growing faster than your financial resources can fund.
Desperation creates a powerful cocktail, and when an email pops up, or a phone call comes in that promises a business loan overnight as long as you have a viable business – any small business owner wants to know more. A phone call to the number in the email results in encouragement because they ask easily answered questions like your annual sales, your profit numbers, the stability of your business – things that make you believe these are real lenders who are asking legitimate questions.
They are encouraging and may even say they’ll check you out and get back to you later in the day. They assure you that your credit score or FICO score doesn’t matter to them, they want to help you grow your business. Within an hour or two, they call back with an affirmative answer that they will loan you tens of thousands of dollars, and the money can be in your bank account the next day.
For a small business owner who is behind on the rent and unable to make payroll, those words provide massive relief and bring many close to tears – At last they found a lender who believes in their business. The loan documents are emailed over. There are a dozen or more pages in very small print, but you need the loan the next day, so you have to get them signed and back to the lender immediately – no time to have them reviewed by an attorney – besides you know the attorney would tell you not to get a loan and you don’t want to hear that right now – your business has its back against the wall.
Watch out for high interest rates
You see the interest rate is 15% which you know is high, but it’s only for 6 months so you’ll pay it off with your increased sales and everything will be fine. True to their word, the $50,000+/- shows up in your bank account the next day, and it is Christmas all over again. You sleep well that night for the first time in weeks, secure in your decision to invest more in the business because you just know this will be the impetus you need to grow.
What the fine print said is that while the interest rate is very high at 15%, you have already crossed that bridge, what you didn’t read is interest is compounded daily turning that 15% into a much higher number. That 15% is not an APR, it is a DPR, adding interest charges daily upon itself.
Buried deep inside the paperwork that you signed is that loan payments will be automatically withdrawn from your business checking account every day. If a payment is rejected because there aren’t enough funds in the account to cover the payment, you will incur a $2,500 fee for each rejection. You have also signed a UCC form allowing the lender to secure a claim on all of your business assets, and you most likely signed a personal guarantee waiving your corporate veil and putting everything you and your spouse own personally in jeopardy.
Your one day of Christmas joy can suddenly turn into a cruel joke and more like the story of the Christmas Grinch. For those who are thinking this can’t be happening because it is usurious and one of the Federal Banking regulators would surely shut them down, you are incorrect. This is not banking, this is factoring – accounts receivable funding. You are obtaining money based on your continuing sales revenue, and the lender now has a right to every penny that comes into your business until the loan is paid off.
- You are solicited through email, direct mail or telephone
- Your credit score does not matter
- They promise to fund overnight
- Interest rate is double digits
- It is a short term loan – usually 6 months.
- They require automatic, usually daily, payments directly from your checking account
Remember your mother’s warning – if something is too good to be true, it is! No matter how desperate you are for funding, do not answer that email or talk to the very pleasant and professional person on the phone. These are scammers in the truest sense of the word, and there are thousands of them. I have seen one small business owner buckle to her knees because of this loan, and another one that is mired in business and personal bankruptcy. Both agree – the brief respite from financial strain was definitely not worth the ultimate cost.
By Penny Pompei for SCORE