What do you do when your bank eliminates your credit line and the credit card companies jack up your rates? That's the situation in which Carlos and Becky Alvarez found themselves recently. The husband-and-wife team founded Audio Wizards, a retailer and installer of car audio systems and accessories in Buford, Georgia. When the credit crunch hit, the company's bank eliminated Audio Wizards' $50,000 line of credit.
Audio Wizards, which has three employees, has been in business for two years in a growing market outside Atlanta. Sales had more than doubled in 2008, to $247,000, and the company, despite the recession, was anticipating another 30 percent to 40 percent boost in 2009. But last November, Audio Wizards couldn't find a bank that would give it a loan to buy inventory. On top of that, credit card companies began raising the annual interest rates on the Alvarezes' credit cards -- some to as high as 39 percent. "We would have been paying all of our profits to credit card companies," says Carlos Alvarez. In desperation, he sat at his computer and started searching the Web. That was how he found On Deck Capital.
Since launching last May, On Deck Capital has doled out more than $20 million in loans, primarily to businesses with less than $5 million in annual revenue. On Deck, which is based in New York City, isn't a bank. The lender is backed by several venture capital firms, including Khosla Ventures and RRE Ventures, and its loans are financed by a $100 million credit line from a hedge fund. Unlike many small-business lenders, On Deck grants loans based on a company's cash flow rather than the personal assets and credit score of the company's owner.
On Deck does it by incorporating newly available online reports from banks, credit bureaus, and credit card providers into its lending model, says founder and CEO Mitch Jacobs. On Deck's proprietary software reviews the past six months of an applicant's sales history and banking records, and makes a decision in about two days. "Prior to advancements in technology, there was no efficient, economical way to evaluate the performance of very small businesses," says Jacobs. "And the result was that lenders made loans on hard assets, which many small companies don't have."
There are a few requirements. Applicants must have been in business for more than one year and be earning at least $3,000 in credit card sales each month. Or, if the company doesn't accept credit cards, it must have been open for at least two years and have an average daily checking balance of at least $3,000. Companies with high sales volume and relatively low average sale prices are more likely to be approved, says Jacobs. The loans are relatively small -- about $30,000 on average -- and must be repaid over the course of one year.
On Deck's loans don't come cheap. The company advertises loans with interest rates ranging from 18 percent to 36 percent, which is more than banks and many credit cards charge. (The average business credit card offers an annualized interest rate of about 12 percent, according to CardRatings.com.) But On Deck's loans are less costly than other types of alternative lending, such as merchant cash advances, which can sometimes charge the equivalent of more than 100 percent in annual interest. Even so, On Deck's payment structure is unconventional.
Rather than issuing a monthly bill, On Deck automatically deducts small payments every day directly from a borrower's checking account. For instance, Audio Wizards received a loan from On Deck for $15,000 at a quoted 21 percent interest rate. Five days a week, On Deck debits $71.48 from the company's checking account. If there's not enough money in the account, a penalty of up to $50 is assessed. Missing three consecutive payments could cause the loan to default. On Deck also charges an origination fee of up to 2 percent of the loan amount (most banks charge 1 percent to 2 percent) and a $25 monthly processing fee.
On Deck requires daily payments instead of letting businesses keep that capital until the end of the month. Its daily-payment structure could raise the cost to the borrower, says Aswath Damodaran, a professor of finance at New York University's Stern School of Business. "There's a value to being able to pay monthly," he says. "This is a good loan for some businesses, especially when liquidity is tight, but borrowers should walk into this situation with their eyes open." On Deck says its stated interest rates are accurate.
The Alvarezes aren't complaining. They are using the money to buy inventory and expand their store. "This loan is great, because I don't have to worry about budgeting for a large payment at the end of the month," says Becky Alvarez. "If we didn't get this loan," adds her husband, "we would have had to scramble to find another option to keep our company growing." Still, the couple hopes that Audio Wizards will soon be able to qualify for an SBA loan.