[House Hearing, 115 Congress]
[From the U.S. Government Publishing Office]
FINANCING THROUGH FINTECH: ONLINE LENDING'S ROLE IN IMPROVING SMALL
BUSINESS CAPITAL ACCESS
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HEARING
BEFORE THE
SUBCOMMITTEE ON ECONOMIC GROWTH, TAX, AND CAPITAL ACCESS
OF THE
COMMITTEE ON SMALL BUSINESS
UNITED STATES
HOUSE OF REPRESENTATIVES
ONE HUNDRED FIFTEENTH CONGRESS
FIRST SESSION
__________
HEARING HELD
OCTOBER 26, 2017
__________
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Small Business Committee Document Number 115-044
Available via the GPO Website: www.fdsys.gov
__________
U.S. GOVERNMENT PUBLISHING OFFICE
27-255 PDF WASHINGTON : 2018
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HOUSE COMMITTEE ON SMALL BUSINESS
STEVE CHABOT, Ohio, Chairman
STEVE KING, Iowa
BLAINE LUETKEMEYER, Missouri
DAVE BRAT, Virginia
AUMUA AMATA COLEMAN RADEWAGEN, American Samoa
STEVE KNIGHT, California
TRENT KELLY, Mississippi
ROD BLUM, Iowa
JAMES COMER, Kentucky
JENNIFFER GONZALEZ-COLON, Puerto Rico
DON BACON, Nebraska
BRIAN FITZPATRICK, Pennsylvania
ROGER MARSHALL, Kansas
RALPH NORMAN, South Carolina
NYDIA VELAZQUEZ, New York, Ranking Member
DWIGHT EVANS, Pennsylvania
STEPHANIE MURPHY, Florida
AL LAWSON, JR., Florida
YVETTE CLARK, New York
JUDY CHU, California
ALMA ADAMS, North Carolina
ADRIANO ESPAILLAT, New York
BRAD SCHNEIDER, Illinois
VACANT
Kevin Fitzpatrick, Majority Staff Director
Jan Oliver, Majority Deputy Staff Director and Chief Counsel
Adam Minehardt, Staff Director
C O N T E N T S
OPENING STATEMENTS
Page
Hon. Dave Brat................................................... 1
Hon. Dwight Evans................................................ 2
WITNESSES
Mr. William Phelan, President and Co-Founder, PayNet, Inc.,
Skokie, IL..................................................... 3
Ms. Katherine Fisher, Partner, Hudson Cook, Hanover, MD.......... 4
Mr. Trevor Dryer, CEO, Mirador, Portland, OR..................... 6
APPENDIX
Prepared Statements:
Mr. William Phelan, President and Co-Founder, PayNet, Inc.,
Skokie, IL................................................. 15
Ms. Katherine Fisher, Partner, Hudson Cook, Hanover, MD...... 36
Mr. Trevor Dryer, CEO, Mirador, Portland, OR................. 42
Questions and Responses for the Record:
Questions and Responses from Hon. Steve Chabot and Hon. Nydia
Velazquez to Mr. Trevor Dryer.............................. 49
Additional Material for the Record:
ETA SB Lending Infographic 2017.............................. 53
ETA Joint SBL Survey......................................... 55
Filling the Gap - Usman Ahmed, Thorsten Beck, Christine
McDaniel, and Simon Schropp................................ 56
PayPal Government Relations.................................. 70
Responsible Business Lending Coalition....................... 73
FINANCING THROUGH FINTECH: ONLINE LENDING'S ROLE IN IMPROVING SMALL-
BUSINESS CAPITAL ACCESS
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THURSDAY, OCTOBER 26, 2017
House of Representatives,
Committee on Small Business,
Subcommittee on Economic Growth,
Tax, and Capital Access,
Washington, DC.
The Subcommittee met, pursuant to call, at 10:04 a.m., in
Room 2360, Rayburn House Office Building, Hon. Dave Brat
[chairman of the Subcommittee] presiding.
Present: Representatives Brat, Luetkemeyer, Evans, and
Clarke.
Chairman BRAT. Good morning. I would like to call this
hearing to order.
And I think we will get underway. I don't know if you are
all familiar with this place, but we have votes this morning at
about 10:30. So we will just go, and we may have to let out for
a few minutes and reconvene after votes. We are not expecting a
huge vote series, but it will probably be 20 or 30 minutes,
just so you all know what is heading our way.
Let's just start off and dig in. I will try to get through
some of this rapidly.
Small-business access to capital has always been a top
priority for this Committee. Access to capital gives small
businesses the resources they need to keep the lights on,
purchase inventory, pay their employees, and expand their
business. For decades, small-business owners typically went to
their local community bank to receive this capital. These banks
were the backbone of how Main Streets across this Nation were
created.
However, the amount of community banks in the United States
has fallen dramatically in recent years, and regulations such
as Dodd-Frank have made it more difficult for small businesses
to acquire loans through traditional means. Therefore, many
small businesses have had to resort to other means to acquire
capital.
One private-sector solution that has grown considerably in
recent years to address this credit gap is online lending.
While it is difficult to estimate the size of this industry,
online lenders originated an estimated $5 billion to $7 billion
in loans to small businesses in 2015, and it is expected to
become a $50 billion industry by 2020.
While this is an emerging industry with several types of
business models to assess risk, mitigate lender exposure, and
obtain the capital to lend to small businesses, online lenders
typically offer smaller loans with rapid approval and funding
times.
This morning, we will hear from a distinguished panel of
witnesses who will give their perspective on recent trends in
the small-business online lending industry and how it fits into
the overall small-business credit market. I appreciate the
witnesses' being here today.
Thank you all very much for coming. I look forward to your
testimony.
I now yield to the ranking member for his opening remarks.
Mr. EVANS. Thank you, Mr. Chairman.
Access to capital is critical to the success of small
business. However, obtaining conventional credit can be
particularly difficult for many small firms. Lending
requirements are much tighter now than they were before the
financial crisis, and small businesses, especially startups,
are still considered a risky bet by many lenders.
Although FinTech provides significant advantages, there are
some drawbacks. FinTech lending platforms reserve the right to
reject small-business applications, just like traditional
banks. In 2014, the Federal Reserve found only 8 percent of
business loan applications are accepted by the larger platform.
Today's hearing will provide members with an opportunity to
learn about the online lending market and how it has helped
increase access to capital for small businesses.
Today, many firms are turning to alternative lending that
operates on an online lending platform. These services have
made hundreds of millions of dollars available to small firms
by offering a number of benefits over traditional sources but
do have some drawbacks. I look forward to hearing from our
witnesses on ways to improve the marketplace and increase
access to capital for the nation's job creators and innovators.
Thank you, Mr. Chairman. I yield back.
Chairman BRAT. Thanks.
If Committee members have an opening statement prepared, I
ask they be submitted for the record.
I would like to take a moment to explain the timing lights
for our panel today. You will each have 5 minutes to deliver
your testimony. The light will start out green. When you have 1
minute remaining, the light will turn to yellow. And, finally,
at the end of your 5 minutes, it will turn red. I ask that you
try to adhere to that time limit as best you can.
And, with that, we will get off to our testimony.
Our first witness today is Mr. William Phelan, the
president and co-founder of PayNet, Incorporated, in Skokie,
Illinois. PayNet provides small-business credit data analysis
to a variety of clients. He also serves on the Advisory Council
on Agriculture, Small Business, and Labor to the Federal
Reserve Board of Chicago.
Thank you for being here this morning. You are recognized
for 5 minutes. Thank you.
STATEMENTS OF WILLIAM PHELAN, PRESIDENT AND CO-FOUNDER, PAYNET,
INC., SKOKIE, ILLINOIS; KATHERINE FISHER, PARTNER, HUDSON COOK,
HANOVER, MARYLAND; AND TREVOR DRYER, CHIEF EXECUTIVE OFFICER,
MIRADOR, PORTLAND, OREGON
STATEMENT OF WILLIAM PHELAN
Mr. PHELAN. Thank you, Mr. Chairman. Thank you for that
introduction.
The financial crisis, as you all state, disrupted the
credit markets. Traditional banks, as you also mentioned, and
even large banks were preoccupied and didn't find lending to be
as profitable. FinTechs jumped in, as you said, Chairman, to
fill the credit gap, but they have their own challenges as
well.
Let me just briefly talk about the credit conditions for
small businesses right now. There is less investment being
taken by small businesses right now. From the period 2015 to
2017, small-business investment is actually down 1 percent,
versus 2005 to 2007 where it was up 12 percent. Having said
that, the financial health of small businesses is extremely
strong right now. Their days-past-due are actually better than
they were before the recession.
Very briefly, let me just mention the size of this market.
It is important to understand the sheer scope of the small-
business credit market. We estimate over $1 trillion in total
credit. Banks make up the biggest portion of that, about $700
billion; commercial finance, about $250 billion. And
alternative finance, or FinTech, is about $5 billion to $7
billion right now.
Briefly, you mentioned the banks and the challenges they
have had. They undergo a credit process. The credit process
consists of 28 different steps. It can cost a bank $5,000 to
$7,000 to complete one credit application, so it is a very
expensive process for a bank. And then they have to spend a lot
of time actually reviewing those loans, and that is another
$1,000 of cost per review.
You mentioned the credit gap, as well, in your opening. I
would like to point out that Harvard Business School conducted
a research study called ``The Decline of Big Bank Lending to
Small Businesses: Dynamic Impacts on Local Credit and Labor
Markets.'' This was authored by Jeremy Stein, an ex-Fed
Governor, and two of his colleagues.
What they found was that fewer businesses expanded
employment as the large big-four banks pulled back on providing
capital. Unemployment rates rose; wages fell. The effects were
concentrated in industries like manufacturing. As a result,
small banks, nonbank finance companies, and FinTechs jumped in
to fill that gap. And so there is evidence of this shown in
this Harvard study.
Wages are lower and that still persists, which means there
is more work to be done.
You mentioned in your memo the size of FinTech, at $5
billion to $7 billion, so I won't dwell on that. They do make
traditional loans. They make working capital loans. There are
several coalitions that have banded together to make disclosure
available, such as the Innovative Lending Platform Association,
the Responsible Business Lending Coalition, and the Electronic
Transaction Association. And they have all instituted
disclosures to help understand the cost of this capital.
Very briefly, I want to point out the credit quality of the
type of businesses that uses FinTech. We have seen their credit
quality improved from 2009 through 2016. The credit scores were
about 660 back in 2009; they were almost 670 in 2016. We have
seen the FinTechs actually increase the balance of the loans
that they are providing small businesses. They were in the
$20,000 size; now they are at the $65,000 size. We have also
seen them expand the length of the loans that they are
providing. These were previously very short-term loans, 6-
month-type loans. Now they are averaging of 15 months.
We have seen that the businesses that they lend to are
actually longer-established businesses. This was really
interesting in some of the research, that showed they are
lending to businesses that have been in business for 10 or more
years to the tune of about 70 percent of their borrowings going
to those kinds of businesses, versus 77 percent for banks. And
they are expanding into diverse industries. We are seeing
lending into retail, health care, accommodation & food,
construction, professional services, wholesale trade,
transportation, administration, and manufacturing.
Very briefly, we at PayNet conducted a study that looked at
what happens to businesses that borrow from online, or FinTech,
lenders. And we see that about 80 percent of them have actually
climbed the credit ladder and have seen their credit and their
financial health improve over that timeframe. So that was an
important finding from the study.
But we also note that there is a long way to go for
FinTechs to be successful. They have done a good job developing
the technology, but they still have work to do on acquiring
accounts, and obtaining access to capital. And they are on the
road towards making this disclosure, which I think is an
important part of what they have to do to further bolster their
business models.
With that, I will wrap up my comments. Thank you.
Chairman BRAT. All right. Thank you, Mr. Phelan. We
appreciate your testimony. That was very good.
Next is Katherine Fisher, partner with Hudson Cook, LLP, in
the Hanover, Maryland, office, where she is primarily focused
on the areas of consumer financial services and small-business
financing.
Thank you very much for being here this morning, and you
may begin your comments. Thank you.
STATEMENT OF KATHERINE FISHER
Ms. FISHER. Thank you. Chairman Brat, Ranking Member Evans,
and Committee members, thank you for the opportunity to present
testimony today regarding financing through FinTech, online
lending's role in improving small-business capital access.
I am here today on behalf of the Commercial Finance
Coalition, a group of responsible finance companies that
provide needed capital to small- and medium-size businesses
through innovative methods.
Small businesses face a gap credit in credit availability.
Commercial Finance Coalition member companies are trying to
close this gap and help spur entrepreneurship so more Americans
can own and operate their own businesses.
In my testimony today, I will provide an overview of the
types of financing available to small businesses, with an
emphasis on some of the more innovative financing options. I
also will address existing regulation on small business, which
is sufficient to protect small businesses.
First, small businesses need choices. Small businesses
benefit from having different types of financing available. A
business owner who is planning for longer-term capital needs
may choose to apply for a loan guaranteed by the Small Business
Administration. These SBA loans are relatively low-cost. They
range typically from $25,000 to $5 million. To apply for an SBA
loan, the loan applicant must submit a business plan, and the
business owner must often use her house as collateral for the
loan.
In contrast, a business owner who has short-term capital
needs may choose to apply for a loan from a nonbank lender or
to sell future receivables to a merchant cash-advance company.
These types of transactions are typically higher-cost than
traditional SBA loans and are in smaller dollar amounts. To
apply for one of these loans, or MCAs, the applicant usually
must submit bank statements showing several months' worth of
revenue, and the business can receive funds in a matter of
days.
MCA companies--these are merchant cash-advance companies--
are primarily balance sheet funders who have an interest in the
success of the business. MCAs are also unique because they
allow the merchant to adjust the terms of the transaction to
match their revenue.
Whatever the type of financing a business owner chooses,
banks alone are not addressing the needs of small business.
Other financing sources are finding success because small
businesses demand them. This demand shows that small businesses
are being underserved by the traditional funding sources.
The MCA and commercial lending spaces are sufficiently
regulated by existing Federal and State laws and regulations.
Both MCA companies and commercial lenders must comply with laws
and regulations affecting nearly every aspect of their
transactions, from marketing and underwriting through servicing
and collections.
Even when they comply with every applicable law and
regulation, small-business lenders must also be wary of the
Federal Trade Commission's powerful authority to prevent unfair
or deceptive acts or practices. Commercial lenders must comply
with additional Federal regulation, and many States subject
them to comprehensive licensing and regulatory schemes.
For example, on the Federal level, commercial lenders must
comply with the Equal Credit Opportunity Act and its
implementing Regulation B, which prohibits discrimination
against protected classes of people in the extension of credit.
The Equal Credit Opportunity Act and Reg B apply to business
credit and provide protection specifically for business
borrowers.
Another example is the Fair Credit Reporting Act, which
requires a funder to have a permissible purpose to pull a
consumer report for a sole proprietor or for an individual
guarantor of a business transaction. This is particularly
relevant in the world of small-business finance, where the
business is often organized as a sole proprietor or the
individual owner will serve as a guarantor in the event that
the business defaults.
Finally, many States require a license to make a loan to a
business, limit the interest rates lenders may charge to
business borrowers, or both. And with State licensing programs
comes regulatory oversight. States that regulate lending also
typically limit the terms of loans, require disclosures and
loan documents, and limit the fees that creditors may impose.
Most State laws regulating lending apply to loans with smaller
dollar values, and these are exactly the types of loans upon
which small businesses rely.
I am very optimistic that FinTech and alternative finance
will fill the void for those underserved by traditional banks
and financial institutions, providing much-needed access to
capital for small businesses.
Thank you.
Chairman BRAT. Thank you, Ms. Fisher. We appreciate your
testimony as well. Thank you very much.
And I will now yield to our ranking member for the
introduction of the final witness.
Mr. EVANS. Thank you, Mr. Chairman.
Our last witness is Mr. Dryer, CEO of--the company is
Mirador? Did I get that right?
Mr. DRYER. Mirador.
Mr. EVANS.--Mirador Finance in Portland, Oregon.
Mr. Dryer received his B.A. in history and literature from
Harvard University before receiving his J.D. from Stanford
University Law School.
Thank you for being here this morning, and you may begin.
Thank you, Mr. Dryer.
STATEMENT OF TREVOR DRYER
Mr. DRYER. All right. Chairman Brat and Ranking Member
Evans, thank you for the opportunity to testify today. It is
really an honor to be here.
As mentioned, my name is Trevor Dryer. I am the CEO of
Mirador, which is a small business headquartered in Portland,
Oregon. Mirador is a white-label, third-party service provider
working with regional, midsized, and community banks, credit
unions, and nonprofit CDFIs. Mirador is dedicated to the
proposition that regulated financial services companies want to
serve small businesses in their communities.
Mirador is not a lender. Our platform focuses on improving
the engagement and experience between borrower and lender,
supporting commercial term loans, SBA-backed loans, working
capital lines of credit, commercial real estate loans, and
small-dollar loans.
When a borrower goes to one of our customers' branches or
to their website to apply for a business loan, they are routed
onto the Mirador platform. However, they likely won't even know
they have left the bank site, and we want it that way.
Borrowers can follow simple steps to fill out the
application, and Mirador technology completes a credit memo by
pulling additional data from public records, credit bureaus,
accounting software, bank accounts, and the IRS, which is
returned to a bank's loan officer with a simple indication of
credit worthiness based on the lender's credit criteria.
We are paid for every credit memo we complete without
regard to the final outcome of the application.
The benefit to our bank customers is a vast reduction in
the time and cost to process the loan. For the borrowers, they
benefit from an equally steep reduction in the time it takes to
go from the application to the funding of the loan.
As we grow our client base, we are creating a network of
partners, borrowers, and lenders passing along customers to
ensure that any small business can gain access to credit from a
regulated institution without having to go through the time and
trouble of starting the application process over each time.
This is also a unique way to increase awareness of low-cost
lenders, such as leader CDFIs, that traditionally do not engage
in marketing activities.
Innovation in the area of small-business lending is
improving acces to capital. However, a number of issues still
negatively system impact this market and place the borrower at
a disadvantage. To that end, I proffer a few recommendations to
further remove pain points for small-business borrowers and
lenders.
First, I strongly encourage the IRS to automate the 4506-T
process for a third party to obtain a tax transcript.
Congressmen McHenry and Blumenauer, as well as the ranking
member of this Committee, Congresswoman Velazquez, introduced
H.R. 3860, the IRS Data Verification Modernization Act of 2017,
requiring the IRS to automate the Income Verification Express
Service process by creating an API, or application programming
interface, which would reduce the paperwork and the waiting
period that currently burdens lenders and borrowers alike.
Second, working with the New York Business Development
Corporation, we have identified an opportunity to increase
referrals of those borrowers unable to gain access to credit
through traditional methods to a mission-based nonprofit lender
by providing Community Reinvestment Act, or CRA, consideration
for referrals. Currently, banks do not receive CRA credit from
referring borrowers to CDFIs or other qualified institutions
when these loans are too risky for the bank to underwrite.
Given the economic development missions of CDFIs to support
small businesses, a successful referral from a bank is
something that regulators should incentivize.
Third, the law should allow credit reports to travel with
referred loan applications. When applying for a loan, numerous
credit inquiries occur from the various lenders considering the
borrower's request even though the borrower is seeking a single
loan. Currently, each lender has to pull a credit report even
if the loan is a referral. The more inquiries, the greater the
impact on a credit score. As a credit score gets lowered, the
cost of capital increases and becomes more difficult to obtain.
Finally, I encourage you to further incentivize the SBA to
improve their technology in making the agency's lending process
more efficient and borrower-friendly. SBA-backed products
remain a vital source of capital for small businesses,
particularly newer businesses and startups. However, the
process and technology used are cumbersome and can deter many
lenders and borrowers from participating. The private sector,
including Mirador, has developed world-class matching
technology, ensuring that borrowers end up approved by a lender
under the most appropriate terms and conditions. The SBA should
be encouraged to look to the private sector for technology
solutions to improve the borrower experience in their flagship
programs, SBA One and SBA Lender Match.
Once again, thank you so much for this incredible
opportunity, and I am happy to answer your questions.
Chairman BRAT. Super. Thank you, Mr. Dryer. We appreciate
your testimony as well.
And I think for the questions I am first going to yield to
my colleague Mr. Luetkemeyer. He has a special interest and
expertise in this area, and we will lead off with some
questions.
Mr. LUETKEMEYER. Thank you, Mr. Chairman. I appreciate the
opportunity to be here today in your Committee.
Ms. Fisher, I am kind of curious, you are advocating, or
represent anyway, the merchant cash advance folks. Is that
correct?
Ms. FISHER. Yes.
Mr. LUETKEMEYER. Would you describe a cash advance as a
loan or an investment? Or how would you classify that?
Ms. FISHER. Sure. Thanks for asking that.
A merchant cash advance is not a loan. It is a purchase of
the right to receive future income from a business. So a small-
business owner can enter into a transaction with a merchant
cash advance funder under which the small-business owner sells
a percentage of its future income. And the merchant cash
advance company then will receive that portion of the small
business' revenue as the small business makes the revenue.
It is a very helpful product for small businesses, in that
payments are not unconditionally required. The payments to the
merchant cash advance company are required only to the extent
that the small business actually creates revenue.
Mr. LUETKEMEYER. Okay. Fantastic.
So I know that in Mr. Phalen's testimony he talks about a
SMART Box. And I am all for disclosures. I think the
individual, the business needs to know what they are getting
into. I think that is important. But I know in the SMART Box
there is an APR disclosure. How do you disclose an APR with a
merchant advance product?
Ms. FISHER. That is a good question. A merchant cash
advance product is not an appropriate----
Mr. LUETKEMEYER. It is not a loan, so, therefore, you don't
really have an APR, right?
Ms. FISHER. And, also, there is no definite term.
Mr. LUETKEMEYER. Okay.
Ms. FISHER. So, because a small business is required to
deliver a portion of their receipts as those receipts are
created, we can't know when those receipts will be created. And
things can happen; like, there can be a tough winter in
Minnesota and business slows down for businesses there and so
receipts trickle in more slowly than expected.
So putting an APR as a measurement on a transaction with no
definite term is not the most helpful----
Mr. LUETKEMEYER. We are trying to fit a square peg into a
round hole, aren't we?
Ms. FISHER. Yeah.
Mr. LUETKEMEYER. You know, I deal with a lot of small-
dollar lending, and I chair the Financial Institutions
Subcommittee in Financial Services, and so I deal with this
stuff all the time. You know, for a long time, I--and I
actually chaired the Financial Services Committee back in
Missouri when I was back in the State house. And I have always
dealt with the problem with APR disclosures for small-dollar
lending anything less than a year. You know, APR, the letters
stand for ``annual percentage rate.'' How do you have an annual
percentage rate on something that is not done on an annual
basis? It is done for 2 or 3 weeks or 6 months at a time. I
really struggle with this.
And I think, you know, quite often, the APR has been
misrepresented. Because, at the end of the day, if I have a
leaky faucet at home and I call my plumber up and he charges 50
bucks, you know, to stop by my doorstep--if goes in and says,
``Oh, you have a tap I just have to fix,'' so within 5 minutes,
you know, 10 minutes there, he fixed my faucet, now, did he
charge me 50 bucks to stop by and pay for his trip out and his
experience and all his tools and all of that, or did he charge
me $300 an hour?
That is the disproportionality of an APR and the
misrepresentation of what is going on with this service charge
for small-dollar lending, which, you know, in your situation
here, quite frankly, isn't going to apply because of the
business model that you have.
So that is my concern with APRs. I think for small-dollar
lending or anything that is less than a year, I think it is an
irrelevant thing. And I hope that that can be something that a
SMART Box can be able to be fixed so it doesn't do more harm
than good, because I think it misrepresents what is actually
going on there.
Mr. Dryer, you made a comment a minute ago with regards to
credit bureau inquiries. And I think this is a very, very
important point, from the standpoint that the more inquiries
that an individual has or business has, it sometimes can have a
negative impact on that person or that business' ability to get
credit. Would you like to elaborate on that just a little bit?
Mr. DRYER. Sure.
Mr. LUETKEMEYER. It seems counterintuitive, because you are
trying to find a way to help people, and actually hurt them by
going through the credit bureau.
Mr. DRYER. That is right. We see, typically, because of the
rules that don't allow one lender to share a credit report with
another, that small businesses often have to apply to several
lenders in order to find one that fits their credit parameters,
their lending parameters. And so you will see sometimes, when
they are looking for the same $50,000 loan, they had to apply
to five or six lenders, and, as they go through the process,
more credit inquiries, lowering their FICO score, which----
Mr. LUETKEMEYER. So how would you fix that for your small
businesses? Because this is really important, because they are
trying to get started, they are struggling, and yet if they
actually try and go someplace and get some funds and that
individual or company or entity goes to the credit bureau, it
is actually a mark against them. How do you solve that problem?
Mr. DRYER. I would solve it by allowing the credit report
to be transferred from lender to lender. If you are applying
for a single loan, even if it is with multiple lenders, that
should be one credit inquiry, in my view. And if you can allow
the borrower to kind of take that data with them, that would, I
think, solve, largely, the problem.
Mr. LUETKEMEYER. I appreciate that.
Thank you, Mr. Chairman. My time has expired.
Chairman BRAT. Thank you.
I will now yield to the ranking member, Mr. Evans, for 5
minutes.
Mr. EVANS. Thank you, Mr. Chairman.
Ms. Fisher, I wanted to probe a little bit more on what my
colleagues just talked about. When applying for finance, does
your industry get personal guarantees that lenders and other
industries receive?
Ms. FISHER. Thank you for that question.
In the merchant cash advance industry, there typically are
personal guarantees, but they are of a different sort than with
a loan. As I explained before, with a merchant cash advance
transaction, the business is only obligated to deliver revenue
to the extent the business creates that revenue. So the
personal guarantee is not a personal guarantee of payment.
The business owner also makes certain promises, such as
they won't divert revenue, you know, they won't open multiple
bank accounts and do funny things with their money. So the
guarantee is a guarantee of those types of promises, not the
guarantee of repayment.
Mr. EVANS. So does that lack of collaboration affect your
business model?
Ms. FISHER. No. I think it affects it in a positive way, in
that it helps only ensure that the business owner, who
typically is the person who can control in a small business
whether they are opening multiple bank accounts, is standing
behind those promises. But it doesn't change the nature of the
product being not absolutely repayable.
Mr. EVANS. Uh-huh.
This is to the entire panel, and I will start with you.
Are you aware of the Small Business Borrowing Bill of
Rights? And do you think its tenets include commonsense tools
to protect small businesses and provide transparency?
Ms. FISHER. Thank you.
I am aware of the Small Borrowers Bill of Rights. I haven't
read it in a while, so I am not familiar with exactly what it
says. I think that, as I recall, there are certain things about
it that are very good. There are certain things about it--I
think it mentions APR, so that would be something that I would
disagree with.
The good news is there are many different industry groups
who are working on best practices. And, although they don't
agree with every practice, they are working hard on coming
together for best practices as a whole. So that is a positive
thing.
Mr. EVANS. Okay.
Other people want to respond to that?
Mr. PHELAN. Sure. Yes. Thank you, Congressman.
We also are aware of all the different disclosures that are
underway now in the industry, and I mentioned some of them in
my opening remarks. And there are different tools for assessing
the cost of these types of loans. We think that the more those
tools are made available, the better for the businesses to
assess the cost of credit.
I think somebody here mentioned that businesses have all
kinds of credit needs and financial needs, and it is hard to
distill this down into any one kind of point of view that can
encompass all these different capital needs or credit needs for
businesses. And so, providing the disclosure and having the
tools available make a lot of sense as a way to help clarify
the cost for the business.
Mr. EVANS. Mr. Dryer?
Mr. DRYER. Yes, we applaud the efforts of the industry to
create more transparency and disclosure. At the end of the day,
that, to me, is what is important, is the small business
understanding what they are getting into.
I think the challenge is, when you have regulated entities
that are subject to regulations requiring a certain disclosure
and then you have industry groups that have taken a different
approach, it can become very confusing for a small business if
they are looking at multiple lenders to really understand the
true costs and the terms of the loans. And we see that can be,
you know, quite confusing.
I don't have a great solution for that, but I think the
more that a small business can be allowed to, you know, compare
proverbial apples to apples, the better it is for the borrower.
Mr. EVANS. Thank you.
Mr. Chairman, I yield back the balance of my time.
Chairman BRAT. Thank you, Mr. Evans.
I think we are actually doing all right on the voting
clock. They are still talking on the floor, so we have done
well today.
I will ask a bit of a technical question, and then in the
back of your minds--you are up here in D.C.; Federal
Government, Federal law, et cetera, regulations. At the end,
maybe just suggest how we can be helpful to you moving forward,
what we can do better, and that.
But I will just start off with more of a narrow question.
We will start with Mr. Phelan and work down.
Currently, the Consumer Financial Protection Bureau, CFPB,
is in the process of implementing Section 1071 of Dodd-Frank,
which would require financial institutions, including online
lenders, to gather and submit demographic data of borrowers to
the government.
What concerns, if any, do you have with this provision? And
how would it affect both small financial institutions and small
businesses?
Mr. PHELAN. Thank you for that question.
Yes, we have worked a little bit with the CFPB to help them
understand this data-collection requirement. It is complex, and
what we find is that the data doesn't exist today, so it is
hard to say where exactly to go to obtain it right now.
We think that the challenge is in creating this massive set
of information and that, it is going to put a burden on the
businesses, ultimately, to report this in the transaction.
There will be some requirements to collect it directly from the
business. The business is really the only source to get it,
because no other sources exist right now.
Then there is the challenge of being able to create this
massive data warehouse. And there are different ways to do it.
What we have discussed with the CFPB, is to utilize current
technology that exists right now to collect this information.
And once that is collected, it must then be crafted into a
finished product that provides an understanding of what is
going on in the lending markets and to understand fair credit,
lending activity.
So the concerns are that it is going to be a massive
project, and it is going to be a very substantial change for
both the business and, I think, even to the CFPB to thoroughly
understand the information from this data set.
Chairman BRAT. Great. Thank you much. I apologize for the
alarm. I have never heard it go off like that before.
But I think I am going to yield my time to Member Yvette
Clarke from New York right now. She is with us, and I want to
make sure we get her questions in, if she has any for you
today. Thank you.
Ms. CLARKE. Certainly. I thank you very much, Mr. Chairman,
and I thank Ranking Member Evans.
I thank our expert witnesses for appearing here today.
We know that the world has changed dramatically over the
past decade alone. We have seen rapid technological advances
that have allowed us to access the world in the palm of our
hands. However, we have also seen generations of family wealth
wiped out due to the mortgage foreclosure crisis.
At the center of all of this lies the financial
technological industry. This crucial industry offers the
promise of easier access to capital for people to open
businesses, afford college, and launch new products. However,
it also means that lenders could be exposed to new forms of
fraud and borrowers could face new forms of soft
discrimination/implicit bias by focusing on nontraditional
lending factors that structurally disadvantage specific
communities.
Our goal as elected Representatives of the American people
is to ensure that the government creates clear, fair, and
effective rules to maximize access to capital while minimizing
risk and discrimination that results from bias.
So my first question is to Mr. Phelan.
Can you please describe what nontraditional factors FinTech
lenders may look toward in making investment decisions? For
instance, is there some means of explaining the story behind
late payments within the confines of your application process?
Mr. PHELAN. Thank you. Thank you for that question.
First, I will start with just the nature of a small
business. A lot of times, small businesses lack the financial
statements in an audited format. They don't really have the
need to present audited financial statements and undertake all
that expense that a public company does. With that as a
starting point, lenders are looking to do a credit assessment.
They are looking to conduct an assessment about the ability to
repay the loan.
So, if you put those two together, first you have to go to
various sources of data to assess the credit of the borrower.
And these sources provide information mentioned in the credit
memo, things like credit bureau information, both on the
personal and the commercial side. There is commercial credit
data that can be used very effectively. Secondly, there are
very creative things done by the FinTechs around collecting
financial cash-flow information through the bank statements.
They can actually look at the cash flows of the business
through the bank statements.
There are other sources that I think have been more hyped
than reality, things like social media, that are interesting
from a credit assessment standpoint, but are unproven. And so I
think those are challenges that have not really been fully
vetted yet.
And then there are other forms of payment records, like the
short-term trade payable information, such as shipping bills,
phone bills, light bills, things like that.
What I think is interesting about online lending is that
the online lenders really never see their applicant. They don't
meet them face-to-face, which is far different than the
community bank structure. In the community bank, you walk into
the branch, you meet the banker face-to-face. And with the
online lenders, this is all done online. It is all done really
through the information and data that doesn't provide a view
into the business itself and important characteristics, other
than, you get name, address, phone number, and name of the
business. You get the payment records and maybe some public
filing information, too. And so that can be distilled down to
create some very credible and reliable credit assessments.
Ms. CLARKE. Very well. Thank you.
Ms. Fisher, in your prepared testimony, you went into
detail about the complexity of merchant cash advances, which
allows for businesses to sell their future receipts for cash up
front. Yet you also claim they are already sufficiently
regulated at the Federal and State level.
Are there any changes that you would like to see made to
the way in which the government regulates MCAs?
Ms. FISHER. Thank you for that question.
My view is that Federal regulation of merchant cash
advances is sufficient. There are Federal laws that touch the
merchant cash advance transaction, as I mentioned, throughout
the transaction, from marketing to underwriting to servicing
and collection. So I don't have any suggested changes.
Thank you.
Ms. CLARKE. Very well.
Mr. Chairman, I yield back. Thank you.
Chairman BRAT. Thank you very much.
And sorry for the rushed feel today. I apologize. On fly-
out days, we usually leave about noon, but, today, for some
reason, it happened a little early. And so I just want to thank
you all for your participation and good spirits today and the
excellent testimony you all provided.
I ask unanimous consent that members have 5 legislative
days to submit statements and supporting materials for the
record. Without objection, so ordered.
This hearing is now adjourned.
[Whereupon, at 10:42 a.m., the Subcommittee was adjourned.]
A P P E N D I X
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House Small Business Committee
Subcommittee on Economic Growth, Tax and Capital Access
``Financing Through Fintech: Online Lending's Role in Improving
Small Business Capital Access.''
October 26, 2017
Testimony by Trevor Dryer
CEO, Mirador Financial
Introduction
Chairman Brat and Ranking Member Evans, thank you for the
opportunity to testify today on the role fintech plays in
helping small business access capital. It is an honor to be
here sharing the insights and experience we have accumulated
working in this important space.
My name is Trevor Dryer and I am the CEO of Mirador, a
small business of 24 employees, headquartered in Portland,
Oregon. In the regulated banking space, Mirador is a 3rd party
service provider and is treated as such by bank examiners. The
cloud-based Mirador platform is a ``white label'' technology
solution marketed under a bank, credit union or CDFI's brand,
enabling them to profitably originate small business loans as
low as $2,500, and offer competitive rates by using technology
to facilitate some of the more labor-intensive parts of the
loan-making process, creating a fast and easy experience for
the small business borrower.
Mirador is not a lender. Our technology supports each of
the following services for customers who are lending: customer
acquisition, application (both online and in branch), loan
origination, underwriting, pre-screening or ``decisioning,''
and decline referrals. As a front-end solution with extensive
back-end functionality, all aspects of our platform focus on
improving the engagement and experience between borrower and
lender. Our technology supports: commercial term loans, SBA
backed loans, working capital/lines of credit, commercial real
estate loans, and small dollar loans.
Our platform is highly-customizable and reflects the
existing credit criteria established by our customers. Our role
in the loan-making process provides us with unfettered
sightlines into current small business lending trends including
types of businesses looking for capital, geographic
distribution of a sample size of small business loans, credit
availability, and the risk appetite for different types of
institutions. I can you from my professional work and my
personal experience, access to affordable capital remains a
major hurdle for small businesses around the United States.
Our customers are regional, mid-sized and community banks,
credit unions, CDFI's and other mission-based lenders. Their
customers are the small businessmen and women in the
communities they service who are seeking loans for as little as
a couple thousand dollars, up to several hundred thousand
dollars or more.
Mirador is dedicated to the proposition that regulated
financial services companies want to serve small businesses in
their communities, and are equipped to do so at competitive
rates with robust consumer protections. Due to a number of
factors including regulatory costs, small business loans below
a certain dollar amount are unprofitable for regulated
financial services entities. However, with the help of
Mirador's technology, our customers make smaller loans
profitable once again, increase the profitability for larger
loans, improve the customer experience for borrowers, and
utilize supplemental underwriting, techniques and data sources
helping more lenders ``get to yes'' for qualified small
businesses.
Borrower Experience
When a lender partners with Mirador, they license our
platform. Again, the platform is highly customizable. We import
the lender's credit criteria and integrate the platform into
the bank's preferred origination channels, whether in-branch,
online or mobile.
Once integrated, applicants seeking a business loan apply
through the bank portal either directly on the bank's website,
or working with an employee who takes the application
information in-branch. Though routed onto the Mirador rails,
the borrower's experience remains on the bank's website with
the ``Powered By Mirador'' phrase and logo at the bottom of the
screen. All of the branding, marketing and compliance
disclosures are determined by the bank and bank regulators.
Applicants will follow simple steps to fill-in their
information and, witht heir affirmative consent, Mirador
technology completes a credit memo by pulling additional data
from public records, credit bureaus, accounting software, bank
accounts and the IRS. The credit memo is transmitted to a
bank's loan officer with an indication of credit-worthiness--
again, based on the credit tolerances the bank has provided.
The indication is communicated through a GREEN-YELLOW-RED
system--green essentially indicating an approval, red a denial,
and yellow a conditional approval pending the acquisition of
more applicant information.
The value to the bank is that, up to this point in the
lending process, a bank employee has not spent time compiling
documents, calling the applicant and calling them again to get
more information to compile a complete credit memo. Our lenders
report as much as a 69% reduction in time spent per
application, and a savings of roughly $1550 per loan
origination. Additionally, our lenders see roughly a 60%
application completion rate, due to the significantly easier,
less labor-intensive application process. Several lenders have
reported seeing a 40-50% increase in loan applications after
implementing Mirador's technology due to this higher
application completion rate, and also being able to attract
borrowers disinclined to go through a cumbersome application
process.
The value for the borrower is spending less than 10 minutes
compiling an application, as opposed to the average time of 30
hours. According to the Joint Small Business Credit Survey
Report of 2016 \1\, borrowers overwhelmingly state ``difficulty
with the application process'' and ``long wait for credit
decision'' as the principle reasons for dissatisfaction with a
borrowing experience, far outweighing rates or repayment terms.
Mirador works hard to efficiently use the borrower's time.
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\1\ https://www.newyorkfed.org/medialibrary/media/smallbusiness/
2016/SBCS-Report-EmployerFirms-2016.pdf
Our adaptive application experience changes and presents
questions based on the borrower's risk. For example, as we
collect information we may seamlessly route a borrower into a
SBA process if too risky for a conventional term loan. We also
use a unique algorithm in compiling the underwriting
information for our lenders and to match a borrower with the
lender most likely to approve a loan. If the borrower is
generally too risky for our partner banks or credit unions, our
technology seamlessly routes, with the borrower's consent, the
application to a non-profit CDFI. Thanks to this routing
ability, the borrower does not need to start the application
process over with the new lender, thus saving significant time.
This is also a unique way to increase awareness of low-cost
lenders, such as CDFIs, that traditionally do not engage in
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marketing activities.
Mirador also provides the bank with deeper analytics about
their application traffic, loan performance and customer mix.
But the real value is getting more small business loans into
the hands of creditworthy applicants. Aside from the licensing
fee, we are paid for every completed credit memo regardless of
the lending decision.
In our mission to provide more small businesses access to
capital through traditional, regulated entities, we are working
with various groups having a small business customer base. By
growing our client base, we envision a neural network of
partners, borrowers and lenders passing along customers to
ensure that any small business can seamlessly access affordable
credit from a traditional, regulated institution without going
through the time and trouble of starting the application
process over again from the start. As our network continues to
grow and the number of small business customers increases, the
technology provided by Mirador will only improve.
What We're Seeing
Often the owner of a small business is the CEO, CFO, CIO,
CTO and likely the person handling all of the day-to-day work
required to keep the business running. In other words, handling
the business' finances is just one more task for the business
owner and often is the task left to the end of the day during
non-business hours. In fact, we have heard reports that less
than 10% of small businesses have a CFO or someone looking
after their finances full-time.
A study in 2015 by the Cleveland Fed found that the #1
complaint of small business borrowers was that the application
process was too cumbersome, and the #2 complaint was that the
process too long \2\. Also, the typical hours of operation for
a bank branch overlap with the hours the business owner is
usually trying to run their business. As such, a time consuming
application process becomes extremely difficult.
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\2\ https://www.clevelandfed.org/community-development/small-
business/about-the-joint-small-business-credit-survey/2015-joint-small-
business-credit-survey.aspx
A 2014 Federal Reserve study calculated the amount of time
the average small business owner commits to applying for a
small business loan. Whether the loan is $1000 or $1 million
dollars, on average it will take over 24 hours to research,
fill out the applications, gather documents and submit the
necessary information needed by the bank for underwriting \3\.
That's 24 hours just to get the process moving forward. There
is still the approval process, underwriting and information
verification handled by the bank.
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\3\ https://www.newyorkfed.org/medialibrary/media/smallbusiness/
SBCS-2014-Report.pdf
It can take weeks for the small business owner to see
capital, if approved. I emphasize ``if'' because underwriting
for small businesses is tricky, time consuming and expensive.
In fact, it will cost a bank just as much to underwrite a
$100,000 small business loan as it does a $1 million loan, a
cost which the Oliver Wyman consulting firm found to be between
$1600 and $3200 per loan application, regardless of loan size
\4\. This leaves very little incentive for the banks to offer
small-dollar loans.
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\4\ https://qedinvestors.com/wp-content/uploads/2015/10/The-Brave-
100-The-Battle-for-Supremacy-in-Small-Business-
Lending--vf.pdf
From this narrative, it is also easy to see why so many
small businesses turn to online lending for their capital
needs. In fact, 21% of small business loans are currently going
to higher-priced, non-bank lenders, and this number is growing
\5\. The online lending community provides 24 hours access,
near-instant approvals, and quick turnaround on capital
available in smaller cash amounts. For so many small
businesses, this is the only logical and available--albiet
often expensive--option to meet their capital needs.
---------------------------------------------------------------------------
\5\ https://www.newyorkfed.org/smallbusiness/small-business-credit-
survey-employer-firms-2016
Mirador Financial was created with these small business
pain points in mind, but also with the understanding that
capital offered by traditional lenders is often less expensive
---------------------------------------------------------------------------
and carries better terms for the borrowers.
Mirador currently works with 20 banks and credit union
partners and 4 CDFIs and our network continues to grow. We
believe our technology brings the necessary conveniences of
online lending to the traditional financial institution space,
offering one more option for the small business owner
struggling to keep up with their work and make ends meet. To
date, we have helped offer over $600 million in loans to over
4,200 customers. These loans range from $1000 to $9.75 million
dollars (a SBA 504 loan in a high-priced real estate market)
with an average loan size of $123,000, both non-traditional
products like merchant cash advance to SBA 7(a) loans. We are
crossing the gap between small business, small dollar lending
and traditional commercial lending.
While innovation is clearly improving access to capital for
small businesses, a number of issues still negatively impact
this market and place the borrower at a disadvantage.
To that end, I proffer three policy recommendations which
can unlock additional capital for small businesses by further
removing pain points for borrowers (and lenders).
Encourage the IRS to automate the 4506T process for a third
party to obtain a tax transcript.
Congressman Patrick McHenry (R-NC) and Earl Blumenauer (D-
OR), as well as the ranking member of this committee
Congresswoman Nydia Velazquez (D-NY), introduced H.R. 3860, the
IRS Data Verification Modernization Act of 2017 requiring the
IRS to automate the Income Verification Express Services
Process by creating an Application Programming Interface (API),
which would reduce paperwork and the waiting period that
currently burdens lenders and borrowers alike.
The current process requires a lender to submit (often via
fax machine) a 4506-T form to the IRS, requesting a tax
transcript which is then used to satisfy income verification
requirements in the underwriting process. According to the IRS,
the lender will receive a response to the request in 2 days or
less. However, the typical experience for the lending community
is far longer than 2 days. Forms are faxed back and forth and
with some routinely returned for corrections based on clerical
errors. In our experience, the 4506-T process averages around a
week per request, and longer if the form is returned due to an
error. In terms of the overall application process for the
small business borrower, this delay is a significant factor in
the decision to abandon the loan process and instead seek
credit through an alternative source.
The McHenry bill would simply require the IRS to move from
a paper-based, fax system to a secure API. Only those third
parties authorized by the IRS to pull transcripts under the
current vetting process would be able to take advantage of the
API. In addition, since a fee is charged ``per pull'', the IRS
could simply increase this fee to cover the cost of converting
to an API.
Provide Community Reinvestment Act (CRA) consideration for
referrals to Community Development Financial Institutions
(CDFIs) and other covered lenders.
Regulated banks frequently partner with CDFIs in order to
satisfy CRA obligations with their regulators. Currently, banks
obtain CRA consideration for providing capital investments,
offering technical assistance and through collaboration with a
CDFI on lending. However, banks do not receive CRA
consideration from referring borrowers to these same CDFIs when
these loans are too risky for the bank to underwrite.
Our CDFI partners are seeing a rise in refinancing in the
small business lending space. When the small business faces an
immediate need for capital, and the traditional, regulated
bank's process is too slow, those businesses frequently turn to
alternative lenders where terms and interest rates are
unfavorable. Oftentimes speed outweighs cost-of-capital when
the alternative means missing opportunities to expand our just
keeping the lights on and the doors open. When the urgency is
gone, these businesses are left with high interest debt and
payments that cut deeply into revenue. In one of many a recent
examples provided by a partner CDFI, a refinanced loan saved a
small business over $6300 per month in payments. That $6300 a
month is another employee or a lease payment on new space for
the business. On average, one of our CDFI partners reports
saving small business borrowers an average of $3900 per month
on the non-bank loans they refinance by extending the repayment
term and lending at a much lower APR (typically no higher than
13%).
Given the economic development mission of CDFIs to support
small businesses, a successful referral from a bank is
something the regulators should incentivize. In collaboration
with the NYBDC, we identified an easy and cost effective way to
encourage these referrals is through providing CRA
consideration. The more options provided to the small business
borrower with minimal additional work, the better those
businesses are served and the greater impact on the overall
economy.
Allow credit reports to transfer with referral loan
applications and prohibit credit bureaus from requiring a new
inquiry for each new lender.
Most individuals know that credit inquiries affect their
credit score. Unfortunately, when applying for a loan, numerous
inquiries occur from the various lenders considering the
borrower's request, even though the borrower is seeking a
single loan. The more inquiries, the greater impact on a credit
score and, as credit scores lower the cost of capital increases
and becomes more difficult to obtain.
When a small business applies for a loan, they expect the
lender to pull a credit report. However, if the lender is
unable to approve the loan but can provide a referral to
another lender, it is reasonable to expect the credit report to
transfer with the application. Unfortunately, the credit
bureaus do not allow the reports to transfer and the small
business experiences another inquiry on their credit for the
same information already obtained for the application that was
denied. This is an unnecessary added cost to the application
and an unreasonable penalty to the small business.
Unless the credit bureaus willingly change this practice of
requiring a new credit report when a loan application is
transferred from one institution to another, a statutory
requirement should be considered.
Finally, I encourage this committee to continue efforts
directed at modernizing and simplifying the loan process
through the SBA. The SBA remains a vital source of capital for
small businesses, particularly newer businesses and startups.
However, the process and technology are cumbersome and keep the
SBA from realizing its full potential as a guarantor. Upgrades
to their systems must continue or the SBA risks losing its
pipeline to online lenders and other fintech players.
SBAOne and SBALine are the flagship programs offered by SBA
to improve the borrower experience and previous SBA
Administrator Contreras-Sweet and current Administrator McMahon
deserve credit for prioritizing modernization in these areas.
SBA staff are working incredibly hard--we know them and we
speak to them often--but need to overcome imbedded constraints
to really modernize these services.
The private sector, including Mirador, has developed world-
class matching technology ensuring that borrowers can be
considered by a lender under the most appropriate terms and
conditions. If the SBA employed this technology, I am confident
that it would enable SBA products to reach more borrowers. SBA
should be encouraged to look to the private sector for
technology solutions, and to apply such solutions to improve
efficiently and the overall borrower and lender experience in
SBAOne and Linc. Speaking purely on behalf of my company and
our customers, it is in our best interest for the SBA to obtain
the best available technology.
Once again, thank you so much for this incredible
opportunity. As I am sure everyone on this committee knows,
small business is the backbone of our economy. These job
creators serve the greater good in their local communities and
the entire US economy. We must do everything possible to ensure
they continue to grow and thrive, creating jobs and opportunity
for Americans.
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