OnDeck Capital’s Controversial Lending Practices

Even though the effects of the recession have eased in the last few years, some small businesses still can’t find banks willing to lend them money. After all, many financial institutions are looking to invest in established companies with little to no risk involved, qualities that most small businesses simply do not have. That’s where OnDeck Capital comes in. This lending startup touts itself as a disruptive financial force that can make loan assessments and send cash to companies within hours.

OnDeck claims its advanced software sets it apart from other lenders. The company crunches numbers drawn from thousands of different variables, from cash flow and expenses to brand reputation and social media chatter. A series of algorithms and metrics then determine the client company’s creditworthiness through its “OnDeck Score.” This number helps determine the amount of money that could be loaned as well as the interest rate to levy on it. All this information is then sent to the client, often just hours after the original loan request. OnDeck’s efficiency has caught the eye of big name investors like Google Ventures and Goldman Sachs. Along with a number of elite venture capitalists, these institutions have collectively poured more than $300 million into OnDeck’s coffers for future loans.

Despite the interest of such major players, OnDeck Capital might not be as innovative as it claims to be. Nearly 40 percent of its loans are given out by “merchant cash advance” outlets, which are essentially payday lenders for small businesses. These brokerages first cold call companies to see if they’re in need of capital. If so, the creditor sends the client’s information to OnDeck to perform an analysis of the company’s data. Once everything checks out, the brokerage makes a loan offer that could carry an annual interest rate as high as 500 percent. OnDeck offers thousands of dollars for each new client these brokerages bring in, a system that has contributed significantly to the startup’s massive growth. The company says it eventually wants to phase out business from merchant cash advance outlets. Still, making the break won’t be easy. Last year OnDeck distributed nearly $400 million worth of these loans, leaving the company at risk of damaging its emerging reputation.

 

Questions:

  1. What makes OnDeck Capital so attractive to small businesses?
  1. How can OnDeck charge high interest rates through “merchant cash advances?”

 

Source: Zeke Faux and Dune Lawrence, “Is OnDeck Capital the Next Generation of Lender or Boiler Room?” Bloomberg BusinessWeek, November 13, 2014. Photo by: GotCredit.

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