Virginia is taking steps to regulate high-cost small business financing

A complicated and often costly financing option for small businesses will be made easier with an order from the State Corporation Commission that dictates what providers must tell users.

An option called sales-based financing is an advance of money to a small business that the small business pays back with a set portion of daily sales.

Essentially, the arrangement, also known as a merchant cash advance (MCA), means that if a small business’s sales are slow on a given day, it will be paid less that day.

But the real cost can be high and the deals can be complicated enough to understand that Del. Cathy Tran, D-Fairfax, decided some standardized disclosures would be a good idea.

“They can be very complex and confusing,” Tran said.

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And it’s easy for people to get in the head — she said she heard that from a lawyer who works with Asian-American businesses in Northern Virginia to figure out such proposals.

“Many restaurants in Richmond were affected; there was one that organized an MCA and when the pandemic hit his business, he couldn’t keep up, so he took another MCA to pay off the first one and almost went bankrupt,” she said.

The General Assembly unanimously agreed with Train’s argument that small businesses deserve some protection, making Virginia one of four states, along with California, New York and Utah, to do so.

The SCC has now approved rules requiring sell-side finance companies to disclose specific information about finance charges, the total amount due, the estimated number of payments and the payment schedule, along with several other important terms.

Virginia also now prohibits “judgment recognition” language in many of these agreements, which prevents going to court to resolve disputes over what has been paid and what is still owed.

The Tran Act says that arbitration to resolve disputes must take place in Virginia, not outside the state, as some sale-based financing agreements require.

And it says that firms offering this kind of financing must register with the SCC so that it and the General Assembly can be kept up to date with the deal, which was largely absent from everyone’s mind.

One big player, the sales-based finance unit of PayPal Inc., told the SCC Bureau of Financial Institutions that it provided about $19 million to 1,143 small businesses in Virginia last year.

About 70 percent of the advances went to borrowers in countries that lost 10 or more bank branches after the 2008 recession, and more than a quarter of the advances went to low- and middle-income businesses, said Bernardo Martinez, a PayPal vice president. for global trade lending, the State Technical Committee reported.

The basic idea has been around since the late 1980s in the form of a three-way transaction in which the advance would be repaid out of a fixed share of the company’s future credit card revenue, with the credit card company handling and paying the distribution between the firm that made the advance, and the merchant who made the sale.

For many small businesses, this meant easier access to funds because the cash flow of the business was important, not the owner’s personal credit rating.

But just like with a credit card, when a consumer makes only the minimum payment, the real cost can turn out to be much higher than first thought.

According to the latest Federal Trade Commission report, in addition to repaying the down payment, small businesses must pay what’s called a “factor,” which is often 20% to 50% of the down payment.

“MCAs have very high costs, including, in some cases, estimated APRs in the triple digits. As a result, many business owners who receive MCAs may find it difficult to successfully repay them,” the FTC said, citing the annual percentage rate for credit agreements.

Sometimes the daily receipt by the MCA supplier from the company’s bank account does not match the company’s profit for that day. This is stated in a lawsuit filed by a New York health care facility against his firm, MCA.

According to a recent report by New York’s online publication The City, because the business owner signed a “declaration of judgment” waiving the right to go to court, MCA received a court order demanding payment of $800,000. news release

The FTC’s report raised concerns that some MCA providers use aggressive and potentially deceptive marketing practices, often paying large commissions to deal brokers.

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