In the past week, a sad article appeared in Bloomberg that tells the story of how some lenders are taking advantage of an arcane New York law that, essentially, allows the lender to wipe out large amounts of money from a borrower's bank account anywhere in the country without notice if the borrower signs a document called a confession of judgment.
The article shares devastating stories on how business owners got lured into high interest loans with rapid paybacks and the minute they started having a tough time paying back the notes, their money is wiped out from underneath them, with their businesses rapidly disintegrating and falling apart.
As you read the article-- and I encourage every business owner to read it carefully-- there are many thoughts that come to mind.
Is this legal? How can lenders be so unethical? How can borrowers be so dumb and naïve to sign their rights away through a confession of judgment without realizing what they're doing?
I suggest that any business owner or entrepreneur put these thoughts aside-- and realize that if you're not careful, you could easily land in the shoes of one of these borrowers.
Let me explain.
Have you ever met a small-business owner or entrepreneur who has never had a cash flow problem? I would bet good money that 99 out of 100 entrepreneurs have faced an unexpected payroll crisis at least once in their careers. Something went wrong, and money is tight.
These junctures are a right of passage and will give you sleepless nights-- I have lived through many myself. Business school doesn't teach you what to do. The school of hard knocks does.
In recent years, a solution has become available that, on the face of it, is much easier then asking a friend for a bridge loan, stretching out a vendor payment a bit, or asking an employee if they can hang tight and be paid two days late.
Welcome to the world of short-term online loans.
If you go to Google, and punch in 'business loan,' you will find hundreds of companies ready to put money into your account in 24 to 48 hours. Tempting in your time of need-- but problem solved?
The issue is that in exchange for the quick cash, the lenders will put you on a leash of a rapid payback with a high interest rate and deposit from your bank account daily, instead of monthly.
You might solve your short-term problem, but in many cases, you've just put your business on crack cocaine.
The pressure of paying back the loan causes you to take out another one, and then one after that. And as you get more desperate you often take on more expensive loans. And as the pressure mounts-- and you end up with one of toughest lenders of the lot-- you will sign your rights away without realizing it. Eventually, your business is out of control.
How to avoid the problem.
My simple tip to avoiding ever being in this situation is to go to your bank and apply for a good old-fashioned boring line of credit, today. It's the best insurance against these predatory practices.
One of the oldest rules in business is that the best time to get money is when you don't need it. Ask your banker for a line of credit for about 10 percent of your top-line sales. It doesn't matter if you never use the money, but when that unexpected speed bump hits you one day, you don't want to go knocking on the door of lender's who smell blood.