Do Small Businesses Need Consumer Financial Protections?

In the aftermath of the crisis spawned by subprime mortgages, Congress is trying to create an agency to police consumer financial products. The latest reports sound like lawmakers are pulling the teeth out of it. But since there’s at least a discussion about how to regulate loans and other financial products sold to consumers, it’s worth looking at where small businesses fit in.

When you look at how many small businesses participate in the financial system, they look more like consumers than like large businesses. Business owners usually have to personally guarantee their debts. The terms and rates that lenders offer them are influenced by owners’ personal credit scores, and loan defaults affect their personal credit as well. This is almost always true for sole proprietors and non-employer businesses, but even in LLCs or small corporations, owners’ personal finances are often entangled with their businesses. (Contrast this to larger enterprises: Does anyone think Dick Fuld’s personal credit score took a hit when Lehman Bros. filed for bankruptcy?)

Here’s the catch. Even though most small businesses resemble consumers in how they participate in the financial system, they don’t get the same protections. That’s because the backbone of laws intended to protect people from predatory financial practices — like the Truth In Lending Act and the Fair Debt Collection Practices Act — do not apply to business-to-business transactions.

This dilemma is most glaring in the new credit card regulations. The law protects consumers from nasty credit card practices like retroactively hiking rates on existing balances. But it doesn’t apply to small business credit cards, even though most of these cards function exactly the same way consumer cards do.

Not every consumer protection should apply to small businesses. Even if you’re operating a one-person business, you’re assuming a certain degree of risk. You should have some financial savvy. You should know when you need a lawyer to vet a contract or an accountant to tell you whether your business is likely to be able to repay a loan. There’s also the question of what constitutes a “small” business. So I’m not saying small firms aren’t distinct from consumers.

But should the solo entrepreneur who takes out a business credit card really not get the same protections she gets on her personal credit card? Think about the Advanta saga. The credit card company, ostensibly marketing only to small businesses, offered thousands of cards at low teaser rates and then jacked APRs up, often above 30%. Advanta’s after-the-fact settlement with the FDIC gave borrowers restitution that was neglible compared to the interest charges and fees most incurred. (Advanta neither admitted nor denied any liability in the settlement.)

Would so many business owners have fallen into the trap if there was a regulator explicitly charged with policing credit card and loan offers to consumers and small businesses? I doubt it. As more people work for themselves, the lines between consumers and businesses are blurring. Regulations haven’t kept up. So if we’re rethinking how to regulate the financial sector, the discussion needs to consider the interests of small businesses as well as consumers.

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