Alternative Finance Roundtable is a monthly discussion with leaders from the industry taking on current topics in the alternative lending space. This month features:
Jesse Carlson, General Counsel, Kapitus
Heather Francis, CEO, Elevate Funding
James Webster, CEO, Rok Financial
Obviously, the elephant in the room is the new disclosure laws coming online in California and New York. The new proposed rules in New York would significantly alter the way you do business, especially if you are based in New York. How are you preparing for these new laws and what do you think the impact will be on the industry?
Heather Francis: At Elevate we have been adjusting for the past year – due in part to our membership with the SBFA we had actionable insight early on. We feel confident in our role to both provide disclosure in California but also educate our referral network on the rules set forth. Elevate does not operate in New York so that is not a challenge we are having to address straight on but from the fringes.
The industry has some challenges coming up on the state levels and companies are going to have to meet those challenges – you can no longer ignore or brush off the talk of regulation.
James Webster: At ROK, we have been keeping our finger on the pulse of regulations for years. We have been anticipating regulations, we are ready to make the changes necessary to ensure we are always compliant. With New York there is still some confusion on how the actual disclosures will need to work, further clarification is needed. Being part of the SBFA has been a tremendous advantage to staying onto of industry changes.
Jesse Carlson: Kapitus has expected regulation for some time, and through the SBFA has been involved in attempting to shape the regulatory landscape for some time. In California, the two significant challenges are 1) the timing of the disclosure, since the DFPI did not follow TILA and allow a single disclosure with the contract, and 2) How to address the requirement that referral partners, i.e., ISOs, follow the disclosure regulation. This should be manageable, for example, by offering multiple options to small businesses, and through continued supervision. We are waiting to see the outcome of the New York regulations, but currently there are some key differences in the details that will require careful consideration.
Interest rates are up, and many experts predict we are heading into a recession. How is business and what do you expect in the industry over the next 6-12 months?
Jesse Carlson: Kapitus hopes that the tightening of credit markets will continue to show the value of non-bank sources of financing for small businesses. While we expect stress and an increase in defaults and bankruptcies as the expected recession takes hold, we also believe that there will be high quality small businesses who continue to need financing during the economic downturn, and so view the next year as period of opportunity.
Heather Francis: Access to capital for funders will most likely become more restrictive and expensive. This will also be seen on capital access for small business owners- we are already seeing a higher credit clientele due to banks turning away small businesses that they feel pose a risk in this environment. I will say that the alternative space had some of its biggest growth coming off the last recession in 07/08 but before that a lot of companies struggled- I expect with our industries desire to compete against banks with more robust products- that the portfolios may be overleveraged, and we will have some companies not make it through the next year.
As the space becomes more regulated (e.g., more registration requirements and fee disclosures) there seems to be increased tension in the brokers/finance provider relationship. Brokers are an important part of the industry ecosystem, but many companies are attempting to shift to a more direct sales approach. What does the future look like for brokers and how will a recession, and higher-cost products, impact the broker/provider relationship?
James Webster: Brokers are a crucial part of the industry. Finance providers have been trying to build direct sales channels for years, some have seen success, but most haven’t. I do feel it’s two separate businesses. The product range is too wide for all lenders to have available products (terms/cost/etc) to offer. That means the right client and right provider must match up perfectly and that usually doesn’t happen. I feel this will cause fewer deals funded internally along with higher origination costs. The model doesn’t work. Even the best providers that have seen some success on the origination side rely heavily on brokers to fulfill quotas and sales goals.
With that, increased regulations, higher-cost products, and even the recession can hurt the broker and do pose challenges, especially the smaller offices that don’t have the resources and knowledge to correctly navigate the industry in the future. It is more crucial than ever that brokers and providers have more communication and better relationships.
Heather Francis: I can speak for Elevate in that we don’t have an internal sales team for a lot of the reasons that James mentioned but regulation does create a new challenge to the relationship because ultimately the funder is responsible for the sales agent representation of the product. I think you will see relationships and partnerships in this space with those that are going to be operating above board and that goes to both sides of the coin.
I believe that SBFA’s Broker Council will assist with managing those relationships between the two sides of the industry and Elevate will feel more comfortable working with partners who are apart of or at least has gone through training put on by SBFA.
James Webster: Great point. And for years, this industry has been made up of good operators and bad operators. There have also been over the years through certain cycles (2010/Covid/and at other random times in the last 15 years) that Providers looked at who they were doing business with and shed off some of the “Not so good ones” I think that will continue to occur and maybe in a larger and harsher fashion for some.
For 15 years in this industry, and the tens of thousands of fundings, I can’t think of a lender that would have one negative thing to say about me and my company, and certainly not one would have a negative thing to say on how we conduct ourselves.
Jesse Carlson: Overall, for years non-bank sources of small business finance have avoided the regulatory scrutiny that comes with consumer lending or transactions. That includes both providers of capital, and brokers, who have coexisted for years and will continue to coexist. Some regulatory developments have been coming for a long time, but they are here, and all participants will have to pay attention to changes and developments, the pace of which will accelerate over the next two years. For example, many brokers may not be aware of the need to register in Virginia to offer sales-based financing. New York may apply its disclosure statute to any company doing business in New York. Keeping abreast of developments and changes will be a key part of the strategy for all participants, and organizations like the SBFA will be crucial in organizing the efforts of individual companies to ensure that the regulation that comes is common sense and doesn’t throw the good operators out with the bad.