The promise and perils of online lending

Originally published on The Huffington Post

Small Business Majority CEO, John Arensmeyer

By all accounts, our economy is continuing on a path of recovery in the aftermath of the recession. And while this should signal good times ahead for our nation’s small businesses, entrepreneurs are still struggling to get what they need most to grow and thrive: access to traditional loans and more reasonable terms on alternative lending.

That’s why we addressed this problem head-on during our access to capital panel on May 12 at our Small Business Leadership Summit–an event that’s brought more than 100 small business owners from around the country to D.C. to speak directly to policymakers, issue experts and members of the Administration about the top issues facing small businesses, including the shortage of lending for entrepreneurs.

Discussions like these are important because while small business confidence is on the rise and entrepreneurs are ready to expand their businesses, very few are getting the credit they need to do so. According to the Federal Reserve Bank of Cleveland, lending for big businesses reached record levels last year, but small business lending still hasn’t caught up with pre-recession levels.

That’s because many traditional lenders see start-ups as risky ventures, or they don’t offer loans that meet the needs of small businesses.

In the absence of traditional bank loans, many small business owners are turning to alternative sources of lending. While these options can help open up opportunities for short-term loans and cash advances, this new breed of lending brings with it its own set of problems–unscrupulous actors who would take advantage of small business owners solely to pad their own pocketbooks.

Catarah Coleman, co-owner of Southern Girl Desserts in Los Angeles, knows firsthand how difficult it can be to dig out from under one of these short-term loans.

Coleman started Southern Girl Desserts out of her home in 2007. After some initial success, Coleman and her business partner, Shoneji Robinson, were invited to open up a shop in their local mall. Unfortunately, Southern Girl Desserts couldn’t get a traditional loan from any of their local banks to cover their start-up costs.

“When we were approached by a broker who said he could get us a loan of $30,000 in three days with limited collateral, we jumped at the chance,” said Coleman.

Coleman and Robinson were able to pay that initial loan off in six months; meanwhile, numerous other loan offers started flowing in. They were still struggling with cash flow issues, so they took out some merchant cash advances, not realizing they were being charged up to 56 percent interest on each of those advances.

“We fell into a terrible financial cycle trying to pay off those cash advances,” said Coleman. “We were living paycheck to paycheck, constantly worried about paying off the advances while making payroll and paying off our other regular bills. I felt like we would never get out from under the debt from those advances.”

Stories like this are unfortunately becoming all too common, and many small businesses can’t keep up with both their bills and their repayments.

Luckily for Coleman, her story has a positive ending. Southern Girl Desserts secured a microloan through Opportunity Fund, a California-based microfinance organization, and they were able to pay off their merchant cash advances. And Opportunity Fund is only charging them 8 percent interest on their loan.

The development of online lending and alternative financing options hold the potential to get needed capital to entrepreneurs like Coleman and to communities that have long been underserved, but it needs to be done fairly and responsibly. As Coleman’s story shows, we need more transparency and oversight in the alternative lending space.

Policymakers should take note and consider regulations that will protect small business owners from being taken advantage of, but it’s equally important that regulations don’t become so stringent that they stifle innovation.

Small business owners are our biggest job creators. And like all businesses, they need credit in order to expand their ventures or turn their business ideas into a reality. It’s time to take steps to protect small businesses from unscrupulous lenders while getting them the capital they need to grow and succeed.