Forget the Algorithms. Get Me a Loan Broker!
Alternative lenders, nonbank firms that provide short-term commercial credit at expensive rates, have been around for years. Today, companies such as OnDeck and CAN Capital boast that their cutting-edge data-gathering techniques and software analytics allow them to make loans to small businesses that banks consider too risky.
Yet these alternative lenders rely heavily on a low-tech method to find borrowers: loan brokers, who funnel cash-strapped small business owners to companies that offer short-term cash advances and other types of high-cost financing. There’s a catch. Loan brokers’ generous commissions can double the cost of already expensive loans, according to industry insiders and paperwork describing commission structures viewed by Bloomberg Businessweek.
Under the terms outlined in a document produced by a CAN Capital subsidiary, a business borrowing $50,000 over six months would end up paying back $65,500, with the broker getting $8,500 for delivering the customer—more than the lender would make on the loan. The 17 percent commission far outstrips the 1 percent or 2 percent brokers earn on loans backed by the U.S. Small Business Administration.
Some lenders 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. “Things got out of control because of the incentives to [mortgage] brokers who had no skin in the game.” Jeremy Brown, CEO of alternative lender RapidAdvance, says the high commissions remind him of last decade’s lending frenzy: “The brokers are getting outsize influence again.”
In the U.S., two dozen alternative lenders that specialize in small, short-term loans provided roughly $3 billion to small businesses last year, estimates Marc Glazer, CEO of Business Financial Services, a lender based in Coral Springs, Fla. The loans, typically less than $100,000 and lasting less than a year, are marketed to businesses that don’t qualify for regular bank loans or don’t want to jump through the hoops of applying. Many alternative lenders pitch products called merchant cash advances. In these arrangements, lenders advance a lump sum and collect payments automatically by diverting a daily cut of the merchant’s credit card sales.
Contracts between alternative lenders and borrowers typically express borrowing costs as a multiple of the loan amount over a specified term. When calculated on an annual basis, the loans can carry the equivalent of triple-digit interest rates.
Lenders rely heavily on online ads, an expensive and unreliable way to drum up business, says Kris Roglieri, CEO of New York-based Commercial Capital Training Group, which charges $23,000 for a weeklong course for would-be loan brokers. By paying brokers only when they close a deal, lenders get more value from their marketing dollars, he says.
As alternative lenders grow bigger and have more money to put to work—some have obtained 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, which says it matches 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, which borrowers don’t see, show how much more the middlemen can add to the cost of a loan. The broker agreement used by the CAN Capital subsidiary shows the lender expects to be repaid 14 percent more than the amount it advances on a six-month loan. But its preferred brokers can tack on an additional 17 percent, bringing the total borrowing cost to 31 percent of the loan. CAN Capital declined to make executives available for an interview. 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.”
OnDeck, which counts Google Ventures among its backers, adds up to 12 percent of the loan amount in transactions involving brokers, 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 industry trade group the North American Merchant Advance Association.
Some entrepreneurs are working to drive down brokers’ fees. Ballentine, a former broker himself, started Buynance in February to let borrowers compare loan offers from multiple lenders. Jared Hecht started a site called Fundera in February to help business owners select the best deals from alternate lenders. Both companies charge fees that top out at 3 percent of the loan amount, a fraction of what brokers collect. “In other industries, the Internet replaces the broker,” says Hecht, noting that websites such as Priceline.com succeeded by giving travelers price transparency they didn’t get from travel agents. That hasn’t happened for small business loans yet.