The Biggest Myth About Online Lending

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(This post originally appeared on Inc.)

Would you pay 35-50% annual interest for a loan from an online lender? Yes, you would.

The past few weeks have not been great or those in the online lending business. Lending Club’s CEO was forced to resign after an internal investigation found that he made inappropriate loans. Google stopped “payday lenders” (those that lend money at more than 36% annual interest and with a payback requirement of under 60 days) from using Adwords. U.S. regulators are now paying closer attention to the industry’s lending practices. Led by companies like Lending Club, Kabbage, CAN Capital, Lendio, Prosper and OnDeck Capital online lending in the United States has tripled in volume in just the past year, reaching a total of $36 billion in 2015 according to this study.

But here’s the catch: these loans are expensive. In most cases much more expensive than banks and even credit cards. When I tell groups of business owners that online lending rates can be as much as 50% annually I get a collective roll of the eyes. Are these companies predatory? Who would do this, they ask me in disbelief. Who would pay this kind of money? Plenty of people do. And for good reason.

Brandon Wall did. He owns Joe’s Coffee, a popular coffee shop located in the tony Rittenhouse Square section of Philadelphia and other locations both in Philly and New York. “It’s a very competitive process when we find a prime location,” Wall said inthis article from Philly.com. “We need to be able to get to lease signature very quickly. Part of that requires security deposits and first month’s rent. As a small business, a lot of us don’t carry these huge cash balances. We need to find that outside funding very quickly.”

So did Brian Linton. In the same Philly.com article noted above, Linton (who owns another coffee shop in the city near Independence Square) said: “They (online lenders) understand what a start-up is trying to do.” The ease and speed of the application process is worth “a few extra [interest] percentage points.”

Robert Abendschoen borrowed money from Kabbage to fund his online comic book store, according to this report in USA Today. He says the cost is more than worth it because he’s more than tripled his investment in new toy and comic book inventory. The same article cites a pizza shop owner who received loans from an online lender in amounts much less than a bank would consider and the owner of a bridal store who borrowed $75,000 online to fund his marketing and inventory because no bank would lend him money due to his lack of collateral. “You grit your teeth and take the money where you can get it,” he said.

Horacio Ceballos, a distributor of health foods, took out a $21,000 loan from CAN Capital (who is also a client of my firm) and agreed that it helped his business stay solvent. “No one had ever given me a loan of that size before.” He said in this report. “My company was growing and I needed to hire an employee desperately. I also needed to buy more supplies. Thanks to this loan, I was able to do all of that. And what was really great was I received the money in two to three days.”

This is not predatory lending. This is just offering capital to those who need it. Sure, loans from online lenders are more expensive than from traditional banks. That’s because traditional banks are lending to those businesses that can put up the collateral and make personal guarantees. These are, in just about every case, bigger and more established companies who can demonstrate historical profits and assets. So they can not only get loans, but they pay a lower interest rate too. And by the way–this isn’t limited to banking. These same larger and more established companies are paying less than the business owners I mention above for just about everything. They get discounts because they buy greater quantities of materials. They pay lower insurance rates because their risk pools are more dispersed. They negotiate discounts on everything from utilities to office supplies because they have more purchasing power.

Are there bad apples in the online lending industry? There are bad apples in every industry. I’m sure that during the next few years more of them will turn up. And the media will be all over it. But that shouldn’t deter you from considering this source of capital. And neither should those high interest rates. Why?

Because it’s a myth that business owners who get loans from online lenders are paying 35-50% interest a year. Maybe a very few do. But take note of the stories above. No one is buying property, equipment or other long term assets with funds from an online lender. They’re using these amounts for short term assets: working capital, inventory, a new hire, down payments on a lease, marketing.

Of course, even for 90 or 120 days the interest rates are much higher than a traditional bank. But what bank is going to loan a small business with little financial history and no collateral anything – even for 90 or 120 days? These are not bigger, more established businesses. They are startups and mom and pops and they’re paying these fees because they have no other choice. But the smart business owners know that, while costly, the use of this capital will provide a profitable return. Hopefully, the investment of these funds will generate the needed cash flow so that they can grow to the point of being eligible for less expensive financing from a bank.

Sure those annual interest rates are high. But smart borrowers aren’t paying interest for a whole year. And besides – we’re small business owners. We’re used to paying more for everything.

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