Alternative lenders that cater to small businesses are a booming industry. Companies such as OnDeck and CAN Capital have attracted hundreds of millions of dollars in venture capital and doled out billions to Main Street merchants. With the help of Silicon Valley backers such as Google Ventures and Accel Partners, they’ve built reputations as technology-driven firms whose vaunted algorithms use social media profiles and other unconventional data to get money to small business owners that banks consider too risky.
But behind the high-tech gloss, alternative lenders rely on an old-fashioned method to find borrowers: loan brokers. These independent agents funnel cash-strapped business owners to dozens of companies that fund merchant cash advances and other high-cost loans. And their sky-high commissions, usually hidden from merchants, can double the cost of already expensive loans, according to industry insiders and documents describing commission structures obtained by Bloomberg Businessweek.
In one example, a business borrowing $50,000 over six months could repay $65,500, with more than half the effective interest going to the broker. The commission of 17 percent far outstrips the 1 percent or 2 percent brokers earn on loans backed by the Small Business Administration.
Some observers and executives in the industry worry that brokers are steering costly loans to small businesses that can’t afford them. “It’s a direct parallel to what happened in the subprime mortgage space,” says Mark Pinsky, chief executive officer of Opportunity Finance Network, an umbrella group for community lenders that make more affordable business loans. “Things got out of control because of the incentives to brokers who had no skin in the game.” Jeremy Brown, CEO of Bethesda (Md.)-based lender RapidAdvance, says that high commissions remind him of the previous decade’s lending frenzy: “The brokers are getting outsized influence again.”
About two dozen alternative lenders provided roughly $3 billion to small businesses last year, estimates Marc Glazer, CEO of Business Financial Services, an alternative lender based in Coral Springs, Fla. The loans, typically for less than $100,000 and lasting less than a year, are marketed as easy to get for businesses that don’t qualify for bank loans or don’t want to jump through the hoops of applying. Many alternative lenders sell products called merchant cash advances. In those arrangements, lenders advance a lump sum and collect payments automatically, by diverting a daily cut of the merchant’s credit card sales.
It’s a lucrative business—some loans can carry effective interest rates that, on an annual basis, would reach into the triple digits, though effective APRs around 30 percent are more common. But finding borrowers can be tricky. Alternative lenders lean heavily on online ads, but that’s expensive and doesn’t guarantee customers, says Kris Roglieri, CEO of Albany (N.Y.)-based Commercial Capital Training Group, which trains would-be brokers. By paying brokers only when they close a deal, lenders can make their marketing costs more predictable, Roglieri says. His weeklong course, which he calls a “business in a box,” costs more than $23,000.
As alternative lenders grow bigger and have more money to put to work—some have gotten credit lines from Wall Street firms including Goldman Sachs and Fortress Investment Group—competition for borrowers is increasing. That’s led to bigger incentives for brokers. “The new battlefield for funders is over who can offer brokers the most dynamic commission package,” says Jay Ballentine, co-founder of New York-based startup Buynance, a website that aims to match lenders and borrowers at a lower cost. Ballentine says brokers, in addition to charging hefty commissions, sometimes demand closing fees of as much as $5,000 that borrowers don’t learn about until they’re ready to sign a contract.
Brokers’ agreements with lenders show how much more the middlemen can add to the cost of a loan. Bloomberg Businessweek obtained a 2013 broker agreement used by a CAN subsidiary that shows the lender expects to be repaid 14 percent above the amount it advances on a six-month term. But its most preferred brokers can tack on an additional 17 percent, making the total cost to the borrower 31 percent of the loan. On a $50,000 loan under those terms, a small business owner would pay back $65,500, with the independent broker receiving more than half of the effective interest.
CAN, which is backed by venture investors including Accel Partners, declined to make executives available for an interview or comment directly on the size of broker commissions. In an e-mailed statement, the company said it uses “a variety of marketing channels and commission structures” and that charges depend on “our proprietary scoring model and the history of that particular company.”
CAN is hardly alone in paying high commissions. World Business Lenders, a New York-based company, lets brokers add up to 14 percent of the loan amount on a six-month loan, according to a document describing its commission structures. A “substantial majority” of borrowers come to the company’s website directly, spokeswoman Anjali Arora said in an e-mail. She added that the company “is sensitive to the total cost to the small business of accessing credit.”
OnDeck, which has raised $180 million in venture capital from investors including Google Ventures and Institutional Venture Partners, lets brokers add up to 12 percent of the loan amount, according to spokesman Jonathan Cutler. He says that on average, the company’s independent brokers earn commissions of 7.5 percent.
Many in the alternative lending industry don’t see rich broker fees as a problem. Most “reputable companies” don’t let brokers tack on more than 12 percent of the loan amount in extra costs, says David Goldin, CEO of lender AmeriMerchant and president of an industry trade group called North American Merchant Advance Association. He says independent brokers can struggle to break even, given what they spend on advertising and other costs. RapidAdvance CEO Brown says some brokers accept lower commissions to reduce business owners’ borrowing costs.
Entrepreneurs such as Ballentine hope to drive broker fees down. Ballentine, a former broker himself, launched Buynance in February to let borrowers compare loan offers from multiple lenders. Jared Hecht, who sold his previous company to Skype for $80 million in 2011, launched a site called Fundera in February to help business owners select the best deals from lenders including CAN, OnDeck, and peer-to-peer lender Funding Circle. Both companies charge fees that top out at 3 percent of the loan amount, a fraction of what brokers collect.
Brokers’ high fees show that small businesses need better solutions, says Fundera’s Hecht. “In other industries, the Internet replaces the broker,” he says, noting that websites such as Kayak and Priceline succeeded by giving travelers price transparency they didn’t get from travel agents. That hasn’t happened for small business loans yet.