Convenience comes at a price in the booming industry of online small-business lending.
Alternative lenders have identified a niche in the market, targeting entrepreneurs who need loans faster and in smaller amounts than many banks are able to provide. Many of these startups also have faced criticism for charging high fees and interest rates, as several speakers pointed out at a small-business banking conference American Banker hosted in November.
The lenders generally argue that borrowers understand the pricing and are willing to pay more for the sake of expediency. But Sam Graziano, CEO and co-founder of the online small-business lender Fundation, says that some borrowers experience belated sticker shock when they refinance online loans and realize, "'Wow, that's how much money I was signed up for.' "
The trouble arises when companies use a cents-on-the-dollar lending model to calculate the cost of short-term loans and fail to sufficiently explain the model to borrowers, Graziano says. "If that's what it is, it has to be marketed a certain way," he says. "There's nothing wrong with the product structure." Fundation, which offers loans with repayment terms between one and four years, uses simple interest rates to calculate costs.
The cents-on-the dollar metric, an alternative to annual percentage rates, tallies the amount of money that will have to be repaid on each dollar borrowed. For example, the lender OnDeck, which uses this metric, explains on its website that a business taking out a six-month loan for $25,000 could pay 17 cents for each dollar borrowed, for a loan cost of $4,250.
The company received a wave of not-so-favorable publicity earlier this year when a report found that the average APR on a pool of its securitized loans was 54%. But OnDeck says its customers are clear on the loan terms.
"If your customer has a 'wow' moment, you've failed," says James Hobson, chief operating officer at OnDeck. "Our customers don't have 'wow' moments."
But, whatever the pricing strategy, alternative lenders are clearly on to something and bankers could take a lesson from them on simplifying the process of taking out loans, says Mitchell Orlowsky, CEO of the marketing firm Ignite Sales.
Orlowsky faults bankers for leaving it up to borrowers to distinguish between small-business loan offerings. The difference between loan products, with varying structures and terms, is "almost unintelligible" for customers, he says.
Making matters worse, potential borrowers who call customer service lines for information frequently encounter employees trained to get off the phone as quickly as possible, Orlowsky says. "That's not good merchandising."
Banks have to do more hand-holding for small-business owners, Orlowsky adds. "They don't have time to think about what products they should use. They want you to do that."