CT is considering “truth in lending” rules for some fintech companies

In the decade following the Great Recession, traditional banks cut back on lending to small businesses, and alternative lenders—many of them online—emerged to fill the void.

Lawmakers in Connecticut are now seeking to regulate the commercial finance companies, which advocates say tend to serve more minority-owned small businesses, and charge them higher rates for less transparent loans or loan-like products.

The Legislature’s Banking Committee passed Senate Bill 1032 earlier this month, which would require certain alternative lenders to disclose an estimated annual percentage rate — the annual interest rate — charged for any financing they offer to small business customers. Violators will be subject to fines of up to $10,000.

“There’s a lot of evidence out there that these products really need to be regulated, or have more adequate disclosure, so people understand what they’re getting into,” said Rep. Jason Doucette, D-Glastonbury, a banking committee co-chairman and a leading force behind the legislation.

A federal bill that sought to apply the consumer protections included in the Truth in Lending Act to small business financing—namely, the required disclosure of APRs—was introduced in Congress in 2021, but never received a vote.

Since then, a handful of states, including California, New York, Virginia and Utah, have enacted similar regulation. Virginia and Utah laws do not require financiers to disclose an estimated APR, but do require several other disclosures. California and New York laws lay out a method for approximating the APR on non-traditional financing products.

The US Consumer Financial Protection Bureau ruled this week that federal legislation does not preempt these state laws.

Connecticut’s proposed law maintains the APR disclosure requirement, which advocates say is essential for small business borrowers to be able to make “apples-to-apples” comparisons between financing products.

The Legislature’s Banking Committee limited the bill to apply only to what is known as “sales-based financing” or “merchant advances.” These financiers provide funding to small businesses in exchange for a percentage of future sales or revenue, drawn directly from a business’s accounts. The total repayment is usually a multiple – say 1.5 times – of the original loan amount, and the loan funds are quickly available, unlike bank loans or venture capital, which can take weeks or months to process and approve.

The Revenue Based Finance Coalition, an industry group that represents these finance companies, told the banking committee that its members make capital available to small businesses, provide necessary flexibility and charge a clear flat fee. In written testimony, RBFC Executive Director Deveron Gibbons said the APR is “not a useful disclosure” for the products these companies offer, and he urged lawmakers to consider modeling Connecticut’s disclosure requirements after Virginia’s.

Alexis Shapiro, general counsel for Boston-based financial technology company Forward Financing, agreed. “The huge advantage of sales-based financing for small businesses is that because we are only entitled to a certain percentage of monthly revenue, if the customer’s revenue decreases, so do their required monthly dollar payments to us,” Shapiro explained in writing. testimony to the Banking Committee. She said clients typically agree to send about 10% of their monthly gross until the financing is paid off.

“Because … it is impossible to know in advance how long it will take a small business to deliver the contracted revenue, APR is an inherently inaccurate and misleading concept for sales-based financing,” Shapiro wrote.

Awesta Sarkash, policy director with Small Business Majority, said with so many new financing products on the market and so many new fintechs popping up online, it’s difficult for small businesses to discern which ones offer fair terms and which ones may be predatory.

“There are a lot of good fintechs out there,” Sarkash said, citing those following the Small Business Borrowers’ Bill of Rights, which her organization supports. But these rights are not codified in law in most places, she said. When borrowers search online for financing, “there’s no guarantee that they’re actually interacting with this kind of fintech.”

Small Business Majority has interviewed business owners about their experiences with cash advance companies, and many said they felt pressured into signing contracts they didn’t fully understand because of their urgent need for cash. The organization said unscrupulous MCAs often change the terms of the financing at the last minute and force business owners to waive certain legal rights.

Sarkash said individual consumers buying a credit card can weigh their options by weighing the annual interest rate each company charges — as required by the Truth in Lending Act. The same protections do not exist for commercial financing. Sarkash and other advocates argue that it’s not fair to assume that a sole proprietor will be more financially savvy than the average consumer looking for a credit card.

“The consequence is that small businesses, typically BIPOC and women small business owners, sign on to higher cost financing products that actually hinder their ability to make their small business a success,” Sarkash said. “Now, some of these products might actually make sense to them. But for the most part, small businesses don’t realize what they’re signing up for.”