Now is the Time for a Universal Set of Alternative Business Finance Best Practices
By: Robert Cook, Kate Fisher, and Chris Chamness
The alternative business finance industry is dynamic, with an increasing number of players brokering and funding a rapidly expanding number of businesses. The growing market for merchant cash advances (“MCA”) and business loans has increased the visibility of this market. The media, state and federal regulators, and the general public are becoming aware of the existence of alternative business finance.
This increased visibility also increases the need for the MCA and business loan industry to create best practices to form clear expectations and codes of conduct for interactions with its merchant customers.
The term “best practices” can mean many things, but for this article we refer to a code of conduct that includes the full disclosure of all fees, no discrimination against businesses or business owners, no unfair or deceptive acts or practices, and the protection of each customer’s data. There are some existing best practice codes out there, but not one that is tailored specifically for this industry and can be universally adopted by all participants.
The purpose of this article is to outline some of the benefits of adopting universal, industry-wide best practices.
Regulatory Scrutiny Demands a Proactive Response.
State and federal regulators are starting to look at the alternative business finance industry, and often with a critical eye. Examples of regulator interest are easy to find.
Earlier this year, Chicago Mayor Rahm Emanuel announced that he will press state and federal agencies to establish regulations for business-to-business lenders and MCA companies. Implicit in this statement was that MCA transactions would also be regulated.
In May, the American Banker published an article titled, “Regulatory Road Likely to Get Bumpier for Alternative Lenders.” The article title and content are not so much media hyperbole, but more of a likely prediction.
Also in May, the House Committee on Small Business held a hearing titled Bridging the Small Business Capital Gap: Peer-to-Peer Lending. In that meeting, small business credit was compared to “consumer debt traps.”
In March, the Federal Reserve Board hosted a Financial Innovations Roundtable in Washington, D.C. The topic posed to the Roundtable was: “How can innovations in small business lending be harnessed to better serve community development small business borrowers?”
Regulatory scrutiny is not surprising considering that the alternative business finance industry currently operates in a space with limited regulation. An increase in the volume of alternative business finance transactions has increased the chance that a merchant will complain to a regulator or state attorney general about a failed relationship with a lender or MCA company.
Consumer advocacy groups have sent delegations to roundtable meetings, with the purpose of presenting sympathetic stories of merchants who signed up for a form of small-business funding they did not understand and got in over their heads – or just got screwed. If the best defense the alternative business finance industry can provide to a sympathetic merchant story is to argue that it represents only one transaction, or that the facts were not as egregious as claimed, then there is a problem.
Regulators generally do not like to see a regulatory vacuum. Commercial transactions are no exception. This is especially true when many merchants are sole proprietors and family businesses, a class of entrepreneurs and employers that politicians are likely to treat with sympathy. The alternative business finance industry, as a whole, should develop and implement best practices to control what many regulators may see as an otherwise unruly industry lacking in regulation.
Self-regulation is more likely to be well-tailored to how the industry operates, and less unduly burdensome, than government regulation. In addition, if strong best practices keep state legislatures and regulators from imposing different regulations, then the MCA industry will operate more efficiently. If different states feel compelled to act, and each state passes different regulations, then the costs of compliance will be much higher.
Industry Standards Will Improve the Merchant Experience
Best practices create a code of conduct that will create an industry standard. Merchants are more likely to know what to expect when many players provide the same basic level of service.
Alternative business finance industry participants may continue to create additional services and features to differentiate themselves, but providing a baseline of good service yields many benefits. Customers will have clearer expectations and will be less likely to complain.
For example, the Online Lenders Alliance (“OLA”) uses the concept of industry standard best practices effectively in the consumer lending space. By certifying that members who adhere to best practices are recognized with an OLA medallion, the OLA has created a differentiator that the best online consumer lending industry participants can tout to their prospective customers.
Additionally, the online consumer lending industry has a compelling argument to regulators that it is self-regulated and self-policing by creating a standard of best practices recognizable to customers. The alternative business finance industry should consider something similar.
Negative Media Attention and the Educational Benefit of Best Practices
With its many different participants, the alternative business finance industry does not have a clear message. The result is that while many MCA companies and lenders market their benefits relative to other companies, there is no message about why the industry as a whole is beneficial. In this void, many media outlets have latched onto the one message that they can easily find – the message from the few merchants who are dissatisfied with their experience. Because it is a bad news story, it is even more enticing to the media.
A robust set of universal best practices could provide a counter-narrative. A commitment to honesty, fair-dealing, and respect for merchant privacy will help the industry appear mature and thoughtful. Best practices also could provide a good starting point for a conversation about why the industry is needed and valued: small businesses need flexible, reliable funding to operate and grow.
“Rules of the Road” Prevent Clashes in a Complex System
The alternative business finance industry has evolved from its infancy in the beginning of the new millennium. Independent sales organizations have increased, along with internal brokering departments in many MCA funders and lenders. Syndication allows actors in the different departments of the same company, or from a different MCA company or lender entirely, to jointly fund new advances and loans. New companies continue to enter the space. Two companies have gone public, and many current players are aggressively expanding.
In this chaotic marketplace, universal best practices could provide some basic rules about how companies should interact. Best practices could decrease confusion, instill order, and decrease confrontation between industry participants.
Additionally, investment in the MCA industry will be more attractive if participants follow the same basic rules.