The Federal Trade Commission’s Bureau of Consumer Protection division recently issued a staff perspective paper on the consumer protection issues facing small business financing. The paper follows the agency’s “Strictly Business” forum, held in May 2019, which examined trends in the marketplace, including online loans and alternative financing products. “The agency remains committed to protecting small businesses,” wrote the agency’s staff, “including in the lending marketplace.”
One of the specific charges of the FTC is the enforcement of Section 5 of the Federal Trade Commission Act, which prohibits unfair or deceptive acts and practices (“UDAPs”). The FTC has been clear that it will use its power to enforce Section 5 in the small business lending space, including the 2018 announcement of the “Operation Main Street” project, designed to identify and prosecute fraud affecting small businesses.
The FTC’s focus on small business lending led to the “Strictly Business” forum, as well as the ensuing staff perspective. The paper includes three main topics, including background on the small business financing marketplace, potential benefits of online financing, and consumer protection concerns. The bureau highlighted the growth of small businesses, including women- and minority-owned businesses, and noted that such businesses often face significant challenges in finding financing, despite the relatively modest amount of average loans — $250,000 or less. Because of these challenges, small business owners often seek financing through alternative and upcoming channels, including online lenders.
The availability of online lending, including a “new diversity of products,” provides certain benefits in the eyes of the FTC, including:
- Potential speed and convenience. Online financing platforms can be easier and more convenient to use, and permit small business owners to seek financing at virtually any time. In some cases, loan applications can be completed within a day or two.
- Potential broader access to credit. Some online lenders offer credit to small business owners who might not ordinarily qualify for traditional loans. “Many online providers appear to specialize in high-risk businesses or owners,” wrote the bureau. Others use alternative data in the underwriting process to forecast a business’s health or potential profitability, including data from online financial accounts, real-time payment processing information, and shipping records.
- Potentially flexible financing amounts, terms, and repayment options. New products also can provide new possibilities for small business owners. These include the options to seek smaller loans, sometimes for as little as a few thousand dollars, and offer repayment terms that permit borrowers to repay within just a few months or even permit variable repayment based on a business’s revenues.
These new products have driven specific concerns regarding consumer protection. The bureau specifically noted the following topics:
- Inconsistent information provided to business owners. While the Truth in Lending Act requires disclosure of key pieces of information including the annual percentage rate, TILA does not apply generally to small business financing. As a result, lenders use a number of different terms to describe the costs associated with their products.
- Small business owner confusion about features. The agency noted that small business owners express confusion regarding the terminology used to describe the costs associated with loans, which likely is a result of a lack of standard lexicon to discuss small business lending. However, “providers should keep in mind that the FTC Act’s prohibitions against misleading claims applies to” products such as online loans. These prohibitions include making claims that are likely to mislead small business owners.
- Concerns regarding merchant cash advances. One of the key topics of the “Strictly Business” forum was the rapid rise of the merchant cash advance, or “MCA.” These lenders typically provide high-cost, short-term cash advances to small businesses to purchase a fixed amount of future receivables. In return, the businesses must pay back the loan with an additional “factor,” often between 20% to 50% of the loan’s amount. These products create specific consumer protection concerns, including the high cost associated with MCAs, aggressive and potentially misleading marketing practices, potentially abusive lending tactics, and potentially abusive collection tactics.