Is OnDeck a Merchant Cash Advance Provider?

Small Business, Small Business Loans
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With its launch in 2007, OnDeck set out to become the alternative to merchant cash advances. That financing option, widely used by small-business owners looking for quick access to capital, is easier to get than a bank loan — but it can be staggeringly expensive and lead business owners into a debt trap.

“In the early days, that was a lot of our business, finding folks who had taken merchant cash advances,” says OnDeck CEO Noah Breslow. “Merchant cash advances had made them sad. We say, ‘Here’s a better alternative.’”

But not all small-business owners are happy with OnDeck’s alternative.

Critics question its role

Some nonprofit groups that support small businesses and are critical of merchant cash advances say OnDeck loans, with annual percentage rates that can reach into the high double digits, can be just as harmful to business owners. OnDeck, some maintain, is just another merchant cash advance provider.

OnDeck is “a short-term, high-cost alternative lender,” says Caitlin McShane, marketing and communications director at San Francisco-based nonprofit lender Opportunity Fund.

Gwendolyn Wright has a more scathing view. The business financing consultant, who has worked with the nonprofit Renaissance Entrepreneurship Center in San Francisco, calls OnDeck “scavengers.”

“They’re going after a vulnerable population just like merchant cash advance companies go after a vulnerable population,” she says. These companies “are in crisis positions and need money to get out of that crisis.”

On an upward trajectory

Amid such criticism from small-business advocacy groups and the media, OnDeck is growing rapidly. The lender has originated about $5 billion in loans since 2007, more than doubling its loan volume annually in 2013 and 2014. OnDeck went public in 2014 and is expanding its reach with partners such as JPMorgan Chase. The default rate of OnDeck borrowers was 6% to 7% over the last two years, according to regulatory filings with the Securities and Exchange Commission. Since reporting of default rates or loan loss rates vary, it’s difficult to determine how OnDeck compares with others in the industry. The Small Business Administration doesn’t make public default rates, a spokeswoman says. The Coleman Report, published by an industry research firm focused on SBA lending, estimated the SBA’s 2015 default rate at 2%. 

But OnDeck’s rate is only slightly higher than the 5.5% loan default estimate for firms with 20 or fewer employees published by research firm WAIN Street. The default rate for loans by microlenders is even lower at 4%, according to a 2014 report from the Aspen Institute, an international nonprofit that tracks trends in microlending.

OnDeck has its supporters and satisfied customers, some of them highlighted in testimonials on the company site. Jim Moseley, CEO of TransGuardian in San Marino, California, says OnDeck helped the logistics software company grow at a time when banks were reluctant to offer him financing.

“Banks only believe in you when you don’t need money from them,” he says in a video on the lender’s site. OnDeck provided funding “to take us over the valleys.”

OnDeck has expanded its role in small-business financing in recent years — it has reached out to nonprofits that serve small businesses, launching a program that gives them free access to its online lending platform. Recently, OnDeck initiated an industry group that promised to standardize the disclosure of APRs in business lending.

But its early years were not so auspicious.

Early missteps at OnDeck

In 2014, the lender acknowledged in a regulatory filing with the SEC that some independent brokers in its network had incentives, mainly higher commissions, to “mislead loan applicants” or were “engaged in disreputable behavior.” It is widely believed that some of those brokers also worked in the merchant cash advance industry.

Shortly before OnDeck’s 2014 IPO, Bloomberg reported that the lender “teamed up with brokers convicted of stock scams, insider trading, embezzlement, gambling and dealing ecstasy.” The piece featured an illustration of an executive holding handfuls of money and with a shark’s head.

The report argued that OnDeck was part of the merchant cash advance industry, “essentially payday lending for businesses.”

OnDeck rejects that characterization. Jim Larkin, OnDeck’s vice president of marketing and communications, says that belief may have been due to “confusion in the early days of the industry when the small-business lending space was comprised primarily of banks and merchant cash advance companies.”

“OnDeck has always offered true business loans,” he tells NerdWallet.

And because it offers loans, OnDeck — unlike merchant cash advance providers — is subject to federal banking regulations.

Similarities to MCA companies

But OnDeck is similar to merchant cash advance companies in two key areas: On its website, it doesn’t disclose term-loan APRs, which are on the upper end at 98% as OnDeck has disclosed in a regulatory filing. Also, borrowers must make automatic daily or weekly payments.

OnDeck’s daily withdrawals can overwhelm borrowers, says Will Davis, CEO of online lender Able Lending. “It’s just the same as a merchant cash advance, effectively.”

“They look like a duck,” he says. “They walk like a duck, and they quack like a duck.”

An OnDeck loan can actually be worse than a merchant cash advance, says onetime customer Jay B Sauceda. The owner of Sauceda Industries — a T-shirt company that also offers third-party logistics services such as processing and shipping to small businesses — notes that merchant cash advance payments are typically based on a set percentage of daily or weekly credit and debit card sales. With OnDeck, the daily or weekly amount is fixed.

Sauceda says he paid $1,400 a week on a $60,000 loan, which he took out to cover an unexpected cash shortfall. “With OnDeck,” he says, “it’s ‘We don’t give a …. You owe us every Wednesday.’” 

Overwhelmed by payments

Jonathan Brereton, CEO of Accion Chicago, a nonprofit financial services company that helps small businesses, says daily payments — no matter the lender or provider — are the most common complaint from borrowers.

“If their revenues are volatile and they know they have this fixed payment every day,” he says, “that creates a lot of anxiety and can lead to overdrafts and a lot of additional expenses as a result.”

Larkin, the OnDeck vice president, acknowledges that daily or weekly payments may be tough for businesses with uneven sales, but he argues the regular schedule can “smooth cash flow” for some, by eliminating a large monthly payment “when other items come due.”

High annual percentage rates

Payment schedules aside, critics point to APRs as an OnDeck flaw. Although loan APRs start at 9%, which compares favorably with other online lenders, OnDeck’s average APR is much higher — at 41%, a regulatory filing shows. Wright, the business financing consultant, says when clients ask her about the lender, she presents the APR as the main deterrent.

“The interest rates are just way too high for a small business to be able to be successful,” she says.

It wasn’t until Sauceda went to a different lender to refinance his OnDeck loan that he learned his APR — which was 64%. The new lender offered him a loan with a 15% APR.

If he’d realized how much the OnDeck loan would cost him, Sauceda says he “would have just sold a kidney or something instead.”

“In those situations,” he adds, “you’re not always thinking clearly.”

Making changes at OnDeck

OnDeck has made moves to change its public image and improve its lending practices in the past few years. It has aligned with nonprofit organizations and small-business advocates to offer better financing options. The lender also has won praise for a program that gives nonprofit lenders free access to its technology.

The program has allowed a St. Louis-based nonprofit lender called Justine Petersen, one of the nation’s top providers of Small Business Administration microloans, “access to a fairly sophisticated underwriting platform that yields performing loans,” says Galen Gondolfi, chief communications officer.

“We couldn’t do this on our own,” he tells NerdWallet. Gondolfi says his company doesn’t have the research and development budget that OnDeck does to create that kind of underwriting infrastructure.

Also, in the wake of complaints, OnDeck took steps to make changes to its broker network. Larkin says the company set up a certification program in 2015 for its brokers, whom OnDeck refers to as funding advisors. Larkin calls the program “rigorous” and says it has helped to improve the customer experience. Last year, funding advisors represented 20.5% of OnDeck’s loan originations, down from nearly 46% in 2013, according to regulatory filings.

New loan options with lower APRs

OnDeck says it has focused on improving loan products as its customer base has grown to include small-business owners who may have once gone directly to a bank for a loan. Its average APR of 41% in the first quarter of 2016 is down from a high average of 63% in 2013, according to a filing with the SEC.

“Overall, we are supportive of efforts to regulate the industry and create a level playing field and create more disclosure for small businesses,” CEO Breslow told NerdWallet in an April 2016 interview.

OnDeck in May 2016 joined with two other major small-business lenders in the online space, Kabbage and CAN Capital, to form an industry group that would come up with disclosure standards for lenders and pricing comparison tools for small-business borrowers. Under these standards, lenders would have to reveal APRs — a key demand of advocacy groups.

OnDeck began posting on its website the APR range for its line of credit late last year, Larkin says, and plans to do the same for term loans before the end of 2016.

‘Huge step forward’

Accion Chicago CEO Brereton calls OnDeck’s initiative on disclosing APRs “a huge step forward.”

He describes OnDeck as an evolving player in small-business financing. Given the lender’s position in the market, its moves are significant.

“They’re the most visible brand, which inherently draws attention to them,” Brereton says. “What OnDeck does is very important as far as setting the tone for others.

“They’ve probably been criticized more than other lenders in the space. I think much of the criticism has been appropriate, but there are certainly worse actors out there.”

Benjamin Pimentel is a staff writer at NerdWallet, a personal finance website. Email: bpimentel@nerdwallet.com. Twitter: @benpimentel.