PALO ALTO, Calif. — In ads on Snapchat and Hulu, Earnin makes a pitch to people who need cash right away: The smartphone app allows people to access money they’ve already earned before payday. In exchange, Earnin encourages users within the app to “tip” about 10 percent of the cash they receive.

“What we’re telling people is that you should have access to your pay,” CEO Ram Palaniappan said in a recent interview with NBC News at the company’s Palo Alto headquarters. “Your pay should not be held back from you, and we’re trying to give access to your pay.”

Earnin CEO Ram Palaniappan Courtesy Earnin

Earnin, which was recently endorsed by the celebrity pastor T.D. Jakes and invested in by the rapper Nas, has taken great pains to avoid being seen as a traditional lender. The startup internally calls money transfers “activations” instead of “loans” and frames its business as a way of leveling the financial playing field for those without easy access to credit.

But critics say that the company is effectively acting as a payday lender — providing small short-term loans at the equivalent of a high interest rate — while avoiding conventional lending regulations designed to protect consumers from getting in over their heads.

Earnin argues that it isn’t a lender at all because the company relies on tips rather than required fees and does not send debt collectors after customers who fail to repay the money.

Earnin says it is exempt from a 2017 federal rule on payday lending that requires lenders to ensure that customers have the ability to repay the money they borrow, and from the Truth in Lending Act of 1968, which requires lenders to disclose their annual interest rate.

“This is absolutely a new and different way to skirt the laws around payday lending,” said Jill Schupp, a Democratic state senator from Missouri who represents the St. Louis suburbs and plans to revise her pending payday-lending regulation bill to encompass Earnin.

“To use the word ‘tip’ instead of a usury charge, an interest rate or a fee, it’s just semantics,” Schupp said. “It’s the same thing at the end of the day.”

Payday lenders flourished in the 1990s and 2000s but have declined in recent years due to pressure from consumer advocates and regulation. And while the U.S. economy has improved, worker wages have shown little growth, leaving open a continued demand for short-term loans.

Earnin’s rapid growth — it is the largest of a handful of companies that provide this type of service and raised $125 million in investment last December — has recently drawn scrutiny from state regulators and lawmakers, including Schupp. Payday lending is illegal in 15 states and Washington, D.C., but Earnin operates nationwide.

In New York, the Department of Financial Services is investigating whether the company has run afoul of a law banning payday lending, Earnin confirmed. In Alaska, the Banking Division at the Department of Commerce recently reopened a similar inquiry, the chief of enforcement told NBC News. New Mexico’s Financial Institutions Division plans to send a letter to Earnin to ensure the company is complying with the state’s new ban on payday lending, the office’s director said. And in California, which allows payday lending, a bill that passed the state Senate seeks to impose fee and tip caps on companies that operate like Earnin and its competitors.

One former Earnin user, Nisha Breale, 21, who lives in Statesboro, Georgia — another state where payday lending is illegal — said she hadn’t fully realized that, when converted to an annual percentage interest rate, what seemed like a small $5 tip on a $100 advance payment (repayable 14 days later) was actually equivalent to a 130 percent APR.

“I definitely didn’t think about the payback time and the interest,” Breale, a student at Georgia Southern University, said. “They just portray it as being so simple and so easy.”

In response to questions from NBC News, Kayla Wood, a company spokeswoman, wrote in an emailed statement that “Because Earnin is the first financial company to be built on the belief that people should be able to choose what to pay for the financial services they need, we expect and welcome conversations with regulators about our business and how the community works.”

Wood suggested the names of three banking law professors for NBC News to interview to better understand Earnin’s business model and how it fits into lending regulations.

One of the professors, Todd Zywicki, a law professor at George Mason University, said that Earnin’s legal explanation made sense to him.

“This doesn’t look like anything I would consider to be a loan,” he said. “Unless they are actually somehow forcing or tricking people into tipping, I just don’t see that there’s any problem with it.”

But the other two professors questioned Earnin’s defense of its business model. In particular, they disagreed with Earnin’s claim that it is offering a “nonrecourse liquidity product,” not a loan, because the company has committed not to legally pursue customers who fail to repay the money.

“That’s a mouthful to say: ‘We are a loan but we don’t want to be regulated as a loan,’” said Adam Levitin, a banking law professor at Georgetown University.

How Earnin works

At his previous company, RushCard, which featured a prepaid debit card, Palaniappan said that employees sometimes asked him for an advance on their paycheck. Eventually he opened this practice to others outside the company. By 2012, this had morphed into a startup called Activehours, which later rebranded in 2017 as Earnin.

“When I did that,” Palaniappan said of advancing workers their paychecks, “I realized that their life was so much simpler. They were paying their bills on time, there were no more overdraft fees and no more payday loans. And that’s how it started.”

Since 2015, the analysis firm Apptopia estimates that Palaniappan’s app has been downloaded more than 12 million times. More than half of those downloads came within the last year.

Earnin users verify their employment by sharing their GPS location and allowing the app to access their bank account, to show that they are working regularly and that paychecks are coming in. If the income is irregular, users may be asked for pay stubs.

Earnin users can receive $50 to $1,000 per pay period. Earnin

Once they are approved, customers can begin receiving money — from $50 to $1,000 per pay period, with a limit of $100 per day. Before the money is paid directly to their bank account, users are asked to add an optional tip, which defaults to about 10 percent of the amount borrowed but can be dialed down to zero.

Then, when the user gets paid — typically in a matter of days — Earnin automatically withdraws the amount the user took out, plus the tip. If there isn’t enough money in the account, users told NBC News that Earnin attempts to withdraw it again, which can result in customers being charged bank overdraft fees. Earnin says it will reimburse customers for overdraft fees. And Earnin says customers are not obligated to repay the money, but those who do not are cut off from continuing to use the app.

Earnin does not publicly disclose how much money it processes, but screenshots of an internal analytics website shared with NBC News by a current employee earlier this month show that the company moves an average of over $212 million a month. Additional screenshots from the website show that about 80 percent of users tip, totaling about $8 million in monthly revenue for Earnin.

Earnin declined to confirm these figures, saying only, “We do not disclose our financials as a private company.” While customers do not have to tip, choosing not to do so can lower the amount they are allowed to borrow, according to Earnin’s website.

‘Instant gratification’

NBC News spoke to 12 Earnin users, who had a range of experiences with the app. Some appreciated that it gave them access to cash when they needed it, quickly. Others were wary of getting hooked on a cycle of loans and repayments, and some stopped using the app after it caused their bank accounts to overdraft. None had considered when they started using Earnin that what appeared to be a small tip would be equivalent to a high APR.

Kara Eddings, 32, of Big Bear, California, said she has been using Earnin for about 18 months. Eddings, a mother of two children, ages 5 and 6, works full-time as a clerk at a hospital and is also an Instacart shopper to supplement her income. She started using Earnin because she said she had bad credit and couldn’t get a loan elsewhere.

"It’s definitely a vicious cycle.”

Last year, Eddings got into a tough spot when she borrowed $500 through Earnin while she was on medical leave from work. While she was waiting for state disability payments to kick in, Earnin automatically took its withdrawal of the borrowed money from her account. Unlike more traditional lenders that allow loan extensions in exchange for fees, Earnin always takes the money back on a short timeline.

“After Earnin had taken all of their money out, and then after a couple of bills, I had no money,” she said. “Luckily at the time I didn't have to go anywhere. The kids — I found a way to get some gas money to get them to school, I borrowed from my grandma, but it leaves you without any options, really. It’s definitely a vicious cycle.”

Another Earnin user, Brian Walker, 38, said that he used the app three times before souring on it. Walker, an engineer, previously declared bankruptcy and doesn’t use credit cards. He lives in Sioux Falls, South Dakota, where short-term lending is capped by law at 36 percent APR.

The first time he used the app, to take out $100 four days before being paid, he tipped $5. After Earnin pulled his money out of his paycheck, he said he thought to himself: “I’m down $105 and I’m like, damn, I need that $100 again.”

At that point, he started looking more closely at how the app works, and realized that borrowing $100 and paying $5 for it, repayable in four days, was effectively a 456 percent APR.

When he used the app most recently, in July, he says Earnin pulled its $105 two days before he expected, causing his bank account to overdraft. He complained to Earnin, and the company agreed to cover the overdraft fee, according to an email he shared with NBC News.

Still, he decided not to use Earnin anymore.

“I don’t want this instant gratification,” he said.

A fight over regulation

Advocacy groups led by the Center for Responsible Lending, a nonprofit that advocates against predatory lending, have urged the Consumer Financial Protection Bureau to regulate tip-based companies such as Earnin as lenders.

“That is part of the problem with payday loans: $15 per $100 doesn’t sound like much, but it is for a short-term loan, and it adds up with rollovers,” the advocates wrote in a 2016 filing with the CFPB. “Even if users are ‘tipping’ $3 per $100, that is expensive for a short-loan. The consumer can get into the same cycle of reborrowing as with a traditional payday loan; there is no underwriting for ability to repay; and the same problems with failed payments can occur.”

Earnin disagrees with this assessment, and said so in its own filing to the CFPB in 2016, as the agency considered new regulations to restrict payday lending.

Palaniappan wrote that his company did not offer loans, comparing the business model to an “ATM for wages.” He argued that the startup shouldn’t be bound by the new payday lending rules.

The CFPB ultimately agreed, carving out an exemption in its final 2017 payday lending rule for businesses like Earnin that use a “tip” model rather than charging interest. The agency said that these types of pay advances "are likely to benefit consumers” and are “unlikely” to lead to consumer harm.

That decision legitimized Earnin’s business model: It does not have to disclose an interest rate, and it does not have to make sure that customers are able to repay.

Now, though, actions at the state level could restrict Earnin’s operations. Earlier this month, two California Assembly committees approved a bill that would cap the tips and fees that companies like Earnin can charge for their services to $15 per month and would limit the amount customers can take out in a month to half of their earned-but-as-yet-unpaid income. The bill has already unanimously passed the state Senate.

Earnin has urged supporters to tweet against the bill. The legislation has also faced opposition from the National Consumer Law Center, a Boston-based nonprofit that advocates on behalf of low-income consumers and says that the bill doesn’t go far enough in regulating companies like Earnin.

But State Sen. Anna Caballero, a Democrat from Salinas, sees the bill as a good first step toward protecting consumers.

“If somebody is accessing their income, and someone is paying a $20 tip, that’s too much,” she said. Of Earnin, she added, “that’s what gives them heartburn.”