Virginia tries to regulate costly small business financing option

The complex and often costly financing option for small businesses should be made easier by a government corporations commission order specifying what vendors must tell users.

An option called sales-based financing is a small business cash advance that the small business repays with a set percentage of daily sales.

Basically, a deal, also known as a cash trade advance (MCA), means that if a small business’s sales are slow on a given day, its payment on that day will be lower.

But the real cost can be high and the transactions can be complex enough to understand what Del. Cathy Tran, D-Fairfax, thought 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 into trouble—she said she heard it from a lawyer who works with Asian-American businesses in Northern Virginia to sort out such offers.

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

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

The SCC has now approved rules that require sales finance companies to disclose specific information about financing costs, the total amount due, the expected number of payments and payment schedules, and some other important conditions.

Virginia also now prohibits the wording “conviction” in many of these deals, eliminating the possibility of going to court to resolve disputes about what was paid and what was still due.

Tran’s law states that arbitration of disputes must take place in Virginia, not out of state, as required by some sales-based financing agreements.

And it says that firms offering this type of funding must register with the SCC so that it and the General Assembly can stay up to date with the deal, which was almost in full view.

One major player, a division of PayPal Inc. in sales finance, the SCC Bureau of Financial Institutions said it provided about $19 million to 1,143 small businesses in Virginia last year.

About 70% of its advances went to borrowers in counties that lost 10 or more bank branches after the 2008 recession, and more than a quarter of its advances went to businesses in low- and middle-income census areas, Bernardo Martinez, PayPal vice president. for global trade lending, SCC said.

The basic idea has existed since the late 1980s in the form of a three-way transaction whereby an advance would be repaid from a fixed share of the credit card company’s future earnings, with the credit card company handling and paying the share between the firm that made the advance and the seller who made the sale.

For many small businesses, this meant that it was easier to get the funds because it was the cash flow of the business that mattered, not the owner’s personal credit score.

But, as with a credit card, when the consumer makes only the minimum payment, the real cost can be much more than first thought.

According to a recent report from the Federal Trade Commission, in addition to returning the amount of the advance, small businesses must repay what is known as a “multiplier”, which is often between 20% and 50% of the amount of the advance.

“MCAs have very high costs, including, in some cases, projected triple-digit annual interest rates. As a result, many business owners receiving MCAs may find it difficult to successfully repay them,” the FTC said, referring to the annual interest rate on loan transactions.

Sometimes the daily income of the MCA provider from the company’s bank account does not match the income received by the business for that day. This is the subject of a lawsuit by a New York medical startup against its firm MCA.

As the business owner signed a “recognition of judgment” waiving the right to sue, MCA also received a court order demanding $800,000, according to a recent report by New York-based online outlet The City. news release.

The FTC report said that concerns have been raised that some MCA providers are using aggressive and potentially misleading marketing practices, often paying large commissions to the brokers who close the deals.

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