Happy Sunday, friends. This has been an unprecedented week, one that I suspect you are all reeling from. Like us at Novel, I’m sure you have portfolio companies, friends, and others affected by SVB. After the government backstop last weekend, here’s hoping the impacts were minimal on you and the entrepreneurs you support.

There are so many things to discuss: how this happened; the impact on entrepreneurs; the ways in which capital providers rushed to fill the gaps for entrepreneurs; who fills the gap SVB most certainly leaves behind. Will there be more turmoil in the bank sector? How will the rest of this play out? 

But as a result of this week, I have a different question that is nagging at me (and smarter people than me are better suited to opine on the economy and future of the banking sector). It’s one I return to pretty often, and that this week’s events have brought into stark relief for me: why are predatory lenders able to trick entrepreneurs into taking their money? And what do we need to do to put a stop to it? 

This week, like many of you, we saw a huge influx of inbound requests for our capital, as entrepreneurs engaged in a flight to safety (away from banks and toward non-bank lenders). We’re thrilled by this, obviously, as that’s why we’re here: to provide the capital they need to execute their strategies. 

But I was not thrilled when I heard the predicament that several entrepreneurs found themselves in. There are RBF lenders out there providing loans of up to 100% of a company’s annual revenue payable in 1 and 2 years. 100%! This week, we saw several companies that had loans like that, and that were trying to figure out how to get additional capital because – big surprise – they can’t sustain the payments on a 1-year 100% loan. As you know, it’s incredibly difficult to help an entrepreneur out in that case; they are obviously over-leveraged, and refinancing out a predatory lender often involves a higher advance rate than makes sense, and a level of risk that is higher than normal.

One of the companies that we talked to this week that had a loan sized at 100% of its revenue had an even worse story to tell. Their lender, a fintech “RBF” firm, noticed that their cash balance was dipping (because their loan payments were egregious, they couldn't maintain their cash balance even though they were growing), so this lender swooped in to the rescue, offering them more money at worse terms. I’ve observed before that these lenders treat entrepreneurs like a cash machine; a way to simply recycle money with little to no regard for their borrowers’ well-being or ability to achieve sustainability. This is worse than I thought.

You’ve heard me (and others) say before that these predatory loans are like heroin for small businesses. Once they get on that cycle, it’s hard to get off. That lender is nothing more than a dealer, forcing its customer into a position where it has to rely on that lender for more money simply to bridge the ever-widening cash gap that the lender created. And the borrower ends up dope-sick – i.e., watching its cash flee its bank accounts in the form of predatory loan payments faster than it can create new cash with sales, and then that borrower is forced to go back to that lender for more because nothing else will solve the problem. And no other lender will step in.

Well, that part is only partially true as it turns out. Some of these lenders are letting borrowers stack similar loans on top of each other! So the borrower actually can find new loans to get cash, but those loans are generally equally predatory, and just as short-term.

This is wrong, and I think it’s a threat to entrepreneurs and entrepreneurship generally. It’s the job of a lender to not put a borrower in jeopardy. It’s our collective job to support entrepreneurs in any way we can, but not at any cost. 

And I’m not the only one sounding the alarm. It’s part of the reason regulators are paying heighted attention to RBF loans (see below for two more State-level announcements). I used to think the regulators weren’t necessary; that bad actors would just be weeded out as entrepreneurs got wise to their game. Now I’m not so sure. 

Now, I think it’s time to act. Several of you have reached out on this topic before. If you’re interested in helping, let me know.