Financing options have evolved beyond traditional bank loans, paving the way for alternative methods such as revenue-based financing (RBF). This financing model has gained popularity among startups and small businesses seeking capital without the constraints of traditional debt. However, while RBF offers numerous advantages, navigating this realm requires a keen focus on compliance. Particularly with the implementation of disclosure laws and the enforcement by state and federal regulatory agencies.
Why Compliance Matters in Commercial Financing
In the ever-changing world of business finance, compliance plays a pivotal role in maintaining a level playing field for borrowers and funders. For businesses seeking funding through revenue-based financing, adherence to regulatory requirements is essential for several reasons:
Legal Obligations: State disclosure laws were enacted to prevent predatory lending practices and ensure fairness in financial transactions. By following these regulations, funders demonstrate their commitment to ethical practices and protect themselves from potential legal repercussions.
Avoiding Penalties and Fines: Failure to comply with fair lending laws can result in severe penalties, fines, and other punitive measures. Non-compliance can tarnish a funder’s reputation and financial standing, affecting their ability to operate in the market effectively.
Ensuring Borrower Protection: By adhering to fair lending laws, funders promote transparency and protect borrowers from potential exploitation. Overall, providing clear and accurate information about financing terms and conditions empowers borrowers to make well-informed decisions.
Mitigating Risks: Compliance measures are designed to assess and mitigate risks associated with lending activities. By staying compliant, funders can better manage potential risks and improve their overall financial stability.
States with Existing Disclosure Laws
California Code of Regulations Title 10, Chapter 3 (Commercial Financing Disclosures):
Overview: California Code of Regulations Title 1o, Chapter 3, also known as the Commercial Financing Disclosure Law, was enacted to increase transparency in commercial financing transactions. The law applies to certain commercial financing and requires funders to provide borrowers with detailed disclosures of key financing terms and costs.
Applicability: Applies to commercial financing ranging from $5,000 to $500,000.
Required Disclosures: Under this law, funders must provide borrowers with written disclosures that include the total amount of funds provided, the total cost of financing (expressed as an annualized rate), a description of the financing product, and other material terms and fees associated with the deal.
Timing: The disclosure must be given to the borrower before the transaction is consummated, allowing borrowers to fully understand the terms before committing.
Virginia HB 1027 (Broker Licensing and Disclosures):
Overview: Virginia HB 1027 focuses on broker licensing and disclosures in the state.
Licensing Requirements: The law requires funding brokers to obtain a license from the Virginia State Corporation Commission (SCC) to operate legally in the state.
Disclosures: Brokers must provide borrowers with written disclosures of the total costs associated with the deal, including fees, and any other charges. These disclosures aim to ensure borrowers have a clear understanding of the financial implications of the terms.
Utah S.B. 183 (Small Business Lending Disclosures):
Overview: Utah SB 183 addresses the issue of small business lending and aims to enhance transparency in commercial lending to small businesses.
Required Disclosures: The law requires funders to provide clear and accurate written disclosures of key terms and conditions to small business borrowers.
Information Included: The disclosures must include the total amount of funds provided. Additionally, the total cost of the financing, and any other material terms and costs associated with the financing.
Small Business Definition: SB 183 defines “small business” as a business with 50 or fewer employees or less than $5 million in gross annual revenue.
New York Commercial Finance Disclosure Law (Article 8):
Overview: The New York Commercial Finance Disclosure Law (Article 8), was amended to increase transparency in commercial financing transactions. The law applies to certain commercial transactions and requires funders to provide borrowers with detailed disclosures of key terms and costs.
Applicability: The amended law applies to commercial transactions ranging from $5,000 to $2,500,000.
Required Disclosures: Under the amended law, funders must provide borrowers with written disclosures that include the following:
- The total amount of funds provided
- The total cost of financing (expressed as an annualized rate)
- A description of the financing product
- Other material terms and fees
- The name and contact information of the funder
- A statement that the borrower has the right to cancel the deal within three business days of receiving the disclosures
Timing: The disclosure must be given to the borrower at the time a specific offer of commercial financing is made.
The Importance of Compliance
Compliance ensures that funders adhere to ethical practices, protect borrowers from exploitation, and avoid legal repercussions and fines. Furthermore, it fosters trust between funders and borrowers, ultimately leading to more sustainable and fruitful partnerships.
For businesses considering revenue-based financing, it is imperative to work with reputable funders that prioritize compliance and transparency. By doing so, businesses can access much-needed capital. Also, while safeguarding their interests and paving the way for future growth and success.
