In the decade following the Great Recession, traditional banks cut back on small business lending, and alternative lenders — many of them online — emerged to fill the void.
Connecticut lawmakers are now seeking to regulate those commercial financing companies, which advocates say tend to service more minority-owned small businesses, charging them higher rates for less transparent loans or loan-like products.
The legislature’s Banking Committee passed Senate Bill 1032 earlier this month, which would require certain alternative lenders to disclose an estimated annual percentage rate — the yearly interest — charged on any financing they offer to small business clients. Violators would be subject to fines up to $10,000.
“There’s a lot of evidence out there that these products really need to be regulated, or have more adequate disclosures, so people understand what they’re getting themselves into,” said Rep. Jason Doucette, D-Glastonbury, a co-chair of the Banking Committee and a leading force behind the legislation.
A federal bill that sought to apply the consumer protections included in the Truth in Lending Act to small business financing — namely, the required disclosure of APR — was introduced in Congress in 2021 but never got a vote.
Since then, a handful of states, including California, New York, Virginia and Utah, have adopted similar regulations. The Virginia and Utah laws don’t call for financers to disclose an estimated APR but do require several other disclosures. The California and New York laws lay out a method to approximate APR on nontraditional financing products.
The US Consumer Financial Protection Bureau determined this week that federal legislation doesn’t preempt those state laws.
Connecticut’s proposed law maintains the APR disclosure requirement, which advocates say is critical in order for small business borrowers to be able to make “apples to apples” comparisons among financing products.
The legislature’s Banking Committee narrowed the bill to apply only to what’s known as “sales-based financing” or “merchant cash advances.” Those financers provide funds to small businesses in exchange for a percentage of future sales or revenue, withdrawing directly from a business’ account. The total repayment is usually a multiple — 1.5x, for example — of the original loan amount, and the loan funds are available quickly, unlike bank loans or venture capital, which could take weeks or months to process and approve.
The Revenue Based Finance Coalition, an industry group that represents these finance companies, told the Banking Committee that its members make capital available to small businesses, providing needed flexibility and charging a clear flat fee. In written testimony, RBFC Executive Director Deveron Gibbons said APR is “not a useful disclosure” for the products these companies offer, and he urged lawmakers to consider modeling Connecticut’s disclosure requirements after Virginia’s.
Alexis Shapiro, general counsel for the Boston-based financial technology firm Forward Financing, agreed. “The enormous benefit of sales-based financing for small businesses is that, because we are only entitled to a set percentage of monthly revenues, if our customer’s revenues decrease, so too do their required monthly dollar payments to us,” Shapiro explained in written testimony to the Banking Committee. She said clients typically agree to send around 10% of their monthly gross receipts until the financing is paid off.
“Because … it is impossible to know at the outset how long it will take a small business to submit the contracted-for revenues, APR is an inherently inaccurate and misleading concept for sales-based financing,” Shapiro wrote.
Awesta Sarkash, policy director with Small Business Majority, said with so many new financing products on the market and so many new fintechs cropping up online, it’s difficult for small businesses to discern which ones are offering fair terms and which ones might be predatory.
“There are plenty of good fintechs out there,” Sarkash said, citing those who comply with the Small Business Borrowers’ Bill of Rights, which her organization supports. But those rights aren’t codified into law in most places, she said. When borrowers search online for financing, “There’s no guarantee that they’re actually interacting with those types of fintechs.”
Small Business Majority have interviewed business owners about their experiences with merchant cash advance companies, and many said they felt pressured to sign contracts they didn’t fully understand because of their urgent need for cash. The organization said unscrupulously MCAs often change the terms of the financing at the last minute and force business owners to waive certain legal rights.
Sarkash said individual consumers shopping for a credit card can consider their options by weighing the APR charges for each company — as required under the Truth in Lending Act. Those same protections don’t exist for commercial financing. Sarkash and other advocates argue it isn’t fair to assume a sole proprietor would have more financial savvy than an average consumer looking for a credit card.
“The impact is small businesses, usually BIPOC and women small business owners, are signing onto higher cost financing products that actually impede their ability to make their small business a success,” Sarkash said. “Now, some of these products might actually make sense for them. But for the most part, small businesses aren’t aware of what they’re signing onto.”