NEW YORK (AP) — It sounded like a sweet deal: A loan broker walked into Southern Girl Desserts offering the Los Angeles bakery a $40,000 loan that could be deposited in a bank account quickly. Already rejected for a loan from a bank, co-owner Catarah Hampshire took the offer and hired more workers to whip up peach cobblers and sweet potato cupcakes.
Then the daily phone calls from brokers began. Hampshire was persuaded to take out a second loan. Later she took out a third, and then three more. In less than two years, Southern Girl Desserts took out six loans and was in a financial mess that made it difficult to buy ingredients and pay employees.
"We were drowning," says Hampshire. "I don't know how we survived."
Southern Girl Desserts borrowed from companies that make short-term loans or give cash advances to small businesses that are typically structured to be paid back in under a year. Automatic payments are taken out daily or weekly, either from a bank account or from a company's credit card transactions. Annual percentage rates can be as high as 50 percent or more, far above the APRs of traditional small business loans backed by the Small Business Administration. Those currently have APRs below 10 percent.
A growing chorus of critics say short-term loans are bad for small businesses because APRs aren't revealed, they are expensive and they can lead businesses into a dangerous cycle of borrowing over and over again to keep up with payments. In at least two cases, the difficulties didn't end when businesses filed for bankruptcy. Earlier this year two judges sided with plaintiffs in separate cases against one such lender, New York-based On Deck Capital Inc., after it continued to withdraw payments from the businesses while operating under bankruptcy protection. OnDeck says the problems stemmed from clerical errors that are now fixed.
So why would a business owner choose loans with such high rates? Getting loans at lower rates is tough for small business owners looking to borrow $250,000 or less. Banks see the loans as too risky, or not profitable enough, says Karen Mills, who led the SBA for four years and is currently a Harvard Business School fellow. As lenders clamped down during the Great Recession, it became even harder for small companies to get loans, fueling the growth of alternative lenders. "I think it's good," says Mills. "We know there is a gap in small-dollar loans."
But these loans sometimes come at a high price. States have laws that cap interest rates and fees for loans, but most state laws don't apply to business loans, says Carolyn Carter, director of advocacy at the National Consumer Law Center. Also, some lenders partner with banks in states that don't have such laws.
A group of lenders, brokers, advocates and nonprofits are pushing what it calls a Small Business Borrowers' Bill of Rights. The guidelines are aimed at getting lenders to follow standards they say would protect small companies.
One member of the group, Accion, a nonprofit that provides small loans and advice to entrepreneurs, says it has seen an increase in businesses overwhelmed with debt seeking to refinance. About 20 percent of loan applicants at Accion's Chicago office have been seeking to refinance short-term loans so far this year, up from 5 percent in 2014. But most have so much debt Accion can't help. Those companies are connected with lawyers that can either contact the lenders and negotiate a different payment method or help them file for bankruptcy protection.
The city of Chicago, noticing more small businesses struggling with loans and cash advances, plastered ads on buses and trains earlier this year warning of predatory lenders. Mayor Rahm Emanuel has pushed state and federal officials to regulate the industry. City lawyers are also looking at ways to force lenders, through legislation, to be clearer about their costs, says Maria Guerra Lapacek, the commissioner of Chicago's Department of Business Affairs and Consumer Protection. But if they have no physical presence in the city, it's tough, she says.
FROM SWEET TO BITTER
Southern Girl Desserts first borrowed $40,000 from Advance Restaurant Finance, with terms to pay back $1,160 weekly. Advance Restaurant Finance, which is now known as ARF Financial, did not respond to requests to comment.
Five months later, another broker contacted Hampshire and she took a second loan for $50,000 from OnDeck. She wanted the money to keep expanding the business. About $9,300 went to pay off the remaining balance from the first loan. The bakery was charged an origination fee of $1,250 and interest of $18,500. In all, Southern Girl Desserts received $39,500 in cash from OnDeck, and it owed the lender $68,500. A payment of $271 was taken from Southern Girl Desserts' credit card receivables every business day.
Seven months later, an OnDeck representative called with another loan offer that would give the bakery a cash infusion and pay off the remaining balance on the first OnDeck loan. Hampshire agreed. This time, Southern Girl Desserts received $50,000 in cash. It now owed OnDeck more than $110,000.
Since OnDeck is a public company whose stock trades on the New York Stock Exchange, it regularly files paperwork with the Securities and Exchange Commission. In an August filing, OnDeck says that getting customers to take out additional loans or lines of credit is "important" to its future growth. Payment processor PayPal, which has been lending money to its small business customers for less than two years, says 90 percent of borrowers who pay off their loans apply for another. Square, another payment processor, says more than 80 percent of the merchants that have paid off a cash advance take a second one.
The owners of Southern Girl Desserts say they wouldn't have accepted any of the loan offers if they had known the APRs. Hampshire found out later that the loans she took out had APRs of more than 50 percent.
"That was never discussed," says Hampshire. "I mean, I've purchased a home in the past. I know what to look for. I know about APRs, but that information was never disclosed."
But when Southern Girl Desserts took the third loan, Hampshire wasn't thinking about APRs. A refrigerator, mixer and ice machine all broke at the same time. Cash was tight. So Hampshire, desperate to keep the business alive, borrowed money from three different companies, Wide Merchant Investment, Yellowstone Capital and Pearl Capital. None responded to requests for comment.
OnDeck doesn't reveal the APR to borrowers on its website or in loan agreements, but CEO Noah Breslow says the company's customer service agents will calculate an APR if borrowers ask. "We can do that for customers," says Breslow.
However, OnDeck does list APRs in SEC filings. The company reported in August that its average APR, which includes loan terms that can range from six to 24 months, was 46.5 percent during the second quarter of the year, down from 56.7 percent in the same period a year before. OnDeck lists APRs in filings because the SEC asked for them, Breslow says.
Most short-term lenders don't provide APRs on their websites or in loan contracts. That makes it hard for business owners to compare costs, critics say. On its website, OnDeck says a $25,000 six-month loan could cost an average of 17 cents per dollar borrowed. Square says on its website that borrowing $8,500 may cost $9,605, and PayPal says an $8,000 loan may cost $8,445. Another lender, CAN Capital, says a $10,000 six-month loan could cost a business $12,000. Since the lenders are largely unregulated, there are no rules on how they should advertise their products. CAN Capital declined to comment for this story.
PayPal and Square say small businesses prefer to know the cost of borrowing money in dollar amounts, not percentages. "You think in terms of dollars, not interest," the Square website says. But according to a recent online focus group of 44 business owners conducted by the Federal Reserve, small business owners prefer knowing the APR.
Despite the pitfalls that some small business owners have had, there are companies that are pleased with their experience with the loans.
MPD Digital, which sells cables that are used to connect to antennas, has taken out several short-term loans to buy large quantities of cable that it cuts up, reconfigures and sells to its customers.
The Albany, Georgia-based company was rejected for a loan by its local bank because the company didn't have enough cash on hand, says general manager Ray Nelson.
So MPD Digital began borrowing cash from several lenders, including OnDeck, Kabbage and PayPal. They were all paid back within several months. Nelson says the lenders are expensive, but it's the only option.
"We would be stuck," says Nelson. "We couldn't afford to buy enough at once."
Livewell Care, a Los Angeles company that provides caregivers to older people, took two OnDeck loans last year. The cash allowed the company to double its staff and revenue. CEO Dorika Beckett calculated the APR of the OnDeck loan on her own and knew it was costly. When she got another loan with better terms to repay the OnDeck loan early, she wasn't happy about having to pay back all of the interest to OnDeck — a common practice among short-term lenders.
"It didn't seem fair," says Beckett. "I should have clarified that issue, but I wasn't thinking that I would pay it back early when I took it out."
OnDeck says it has since launched a prepayment benefit in December that lets new customers get a 25 percent discount on unpaid interest.
Southern Girl Desserts finally got out of its mess late last year with another loan. This time it borrowed from Opportunity Fund, a San Jose, California-based nonprofit that lends to small businesses. It didn't need to be paid back for three years and had an APR below 14 percent.
Hampshire and Southern Girl Desserts co-owner Shoneji Robison say they tell other small business owners to avoid short-term lenders. In August, they joined the coalition advocating for the Small Business Borrowers' Bill of Rights in Washington D.C.
When their plane landed, Hampshire had two voice messages from brokers offering loans. She ignored them.
"We're smarter now," says Hampshire.
Follow Joseph Pisani at http://twitter.com/josephpisani