In the alternative-lending space, there are some people who may be great business owners, but lack the financial sophistication to discern between loan offers when their backs are up against the wall.iStockphoto/Getty Images/iStockphoto
As alternative lenders for small businesses look to expand their market share in Canada, a number have banded together to bring more transparency to an industry sometimes criticized for taking advantage of borrowers.
Seven non-bank lenders, acting as part of the newly minted Canadian Lenders Association, will soon be using a standardized disclosure form that makes it easier for borrowers to see how much they're actually paying for a loan.
Rather than having key information scattered throughout a dense multipage loan agreement, the "Smart Box" pulls all pertinent payment details into a single sheet. The hope is that the standardized form will make it easier for borrowers to compare different lenders' rates by factoring in both interest and fees.
"The Smart Box gives you that visibility into the total cost of the loan over time, plus APR [annual percentage rate], plus cents on the dollar; all different metrics that are important for thinking about how a loan might be viable for a particular merchant," said Gary Fearnall, Canadian country manager for On Deck Capital, a small-business lender that helped develop the Smart Box tool in the United States.
In addition to On Deck, the other companies participating in the program in Canada are Company Capital, Evolocity Financial Group, IOU Financial, Lendified, Merchant Advance Capital and Thinking Capital.
The Canadian Lenders Association, the industry group bringing the Smart Box initiative to Canada, says the push to improve transparency is about helping its members improve their own businesses by becoming more user-friendly.
"At the end of the day, a borrower is going to borrow based on the relationship they have with you as a lender and the terms that you're putting forward," CLA president Gary Schwartz said. "The easier we can make it for a borrower to evaluate that, the more volume of loans that are going to come through."
There's also, however, a sense that the industry is moving to improve its reputation and avoid future problems with regulators. Alternative lenders – or "innovative lenders," the term preferred by Mr. Schwartz – fill an important market niche, offering loans to early-stage companies and small businesses that have difficulty qualifying for bank loans. They also provide short-term cash infusions to help with supply issues, hiring or marketing.
But with the shorter term-lengths and the higher risk-profile of borrowers, interest rates can be extraordinarily high. "In some cases, if you're borrowing for a short period and a large amount, you might pay 35 or 40 per cent interest," said accountant Andrew Zakharia, founder of Toronto's AZ Accounting Firm, which has clients who use alternative financing. Companies in the alternative-lending space also tend to be aggressive in their sales tactics.
"This is an area where there are some people who are great business owners, but potentially lack financial sophistication and when they have their backs to the wall and have a cash crunch and need money tomorrow, the person who's there fastest and has the shiniest stack of cash is usually the one they go to first," said Cato Pastoll, chief executive of Lending Loop, a peer-to-peer small-business lending platform that is not part of the Smart Box initiative.
Increased transparency is a good first step to improving the image of the industry, Mr. Pastoll said. But more needs to be done to make sure that small-business owners "don't get duped or manipulated into any unfair lending practices," he said, citing hidden broker fees and loans that are structured to make it impossible for borrowers to pay off early and save money.
The sentiment is shared by Mr. Zakharia. The Smart Box initiative is a great start, he said, but only a select few lenders have joined it so far. Another potential problem is that the improved disclosure requirements only apply to fixed-loan products.
Unlike in the United States, the Canadian Smart Box initiative doesn't cover other financial products, such as merchant cash advances. A merchant cash advance differs from a typical fixed-rate loan, in that the loan is secured against income, entitling the lender to a percentage of the borrower's income until the loan is paid off. These loans typically come with steep interest rates and can make it hard to manage cash flow.
Mr. Zakharia cites one client who borrowed $25,000 using a merchant cash advance, and had to pay back $30,000 over six months. "It's costing them $5,000 over six months to borrow $25,000. That's very expensive," he said. "Really the one where more transparency is required is merchant cash advances, that's where someone has a very high cost of borrowing."
The CLA is working to broaden the Smart Box requirements to other financial products, such as merchant cash advances, Mr. Fearnall said.