WASHINGTON: Since 2008, big banks have gotten much bigger. And many small banks are disappearing, swallowed by the big banks or simply going out of business. Little understood, Merchant Cash Advances, are a new tool being used by small businesses to weather unexpected cash demands.
The Washington Business Journal reported on November 23, 2018, in a piece titled “The disappearing bank branch: Fewer branches mean fewer loan options and fewer options for small businesses.” That article highlighting Candy Schibli who is building a coffee roasting business in D.C. Schibli has found that securing a traditional bank loan was “way more frustrating than the real estate search.”
As a result, she is looking at “online lenders, grants and even a private financing round for her growing coffee business.”
Options for small companies are being restricted and alternative providers of capital have become the option of choice for many.
The restricted options for smaller business are largely the result of federal policies that were supposed to protect consumers from risk. The new regulations, mostly implemented as a result of the Dodd/Frank legislation, are much more expensive to comply with, and only the biggest banks can afford to try. This leaves small businesses scrambling for funding options.
Nonetheless, it is ironic that policies aimed at protecting consumers ended up limiting their choices. But that’s exactly what is happening.
Bank consolidation is creating a problem for small business
As banks get bigger, they are less interested in helping boost Main Street companies. They are seeking big dollar amount of reserves stored in bank accounts. Owners of small operations, the sort that exists from week-to-week or even day-to-day, are being forced to fund themselves.
Luckily, there are alternatives, such as the merchant cash advance model.
The corporations that promote this concept have thought it wise to form the Commercial Finance Coalition. The goal of this group is to promote best practices to reduce concerns of local, state, and federal regulators over self-policing.
Getting Capital to a Small Business
With every new, innovative model of providing capital to the smaller business, there is an educational curve. Politicians must understand the great value of increased access to needed money for so many small businesses who don’t want to use a slow, paperwork-intensive way to access emergency or short-term funding.
The concept is here is simple: a merchant needs some cash and a Merchant Cash Advance (MCA) provider makes it available. Now, this isn’t a traditional loan, as from a bank or even a wealthy relative. Instead of charging interest, a merchant cash advance provider may instead take a stake in the company.
Short term loans at higher rates can make sense
The cash advance is usually just a short-term agreement, so you can think of it like renting a hotel room. If you plan to live in a city for 30 years, using a traditional mortgage to buy a house makes sense. If you plan to live in a city for a few years, a year-to-year rental of an apartment makes sense.
But if you’re only staying in a city for a few nights, a hotel room is a better option. Yes, it may cost $100 a night, which would be $36,000 per year. But if you’re only staying a short time, it’s well worth it.
Small business owners that turn to this model understand the concept.
They aren’t dummies; in fact, they’re expert negotiators who have experience dealing with suppliers, employees, and lenders. These company owners understand they’re entering an agreement that may cost them more than a traditional loan would.
Yet they know that these deals are perfect for businesses that have a sudden, unexpected expense. Maybe the delivery truck breaks down, and they need to get their products out right away. Or maybe they need to repair a leaky roof before their merchandise is destroyed. Or perhaps they’re running a seasonal business and need to maintain some cash flow through lean months.
Another problem is the recently restricted options for traditional small business loans as experienced by Candy Schibli and her coffee roasting business.
New business agreements mean greater flexibility
In any case, successful business owners across the country are entering into these types of agreements. That alone highlights the importance of maintaining this business model. It’s a step that some successful people take, sometimes, to keep their success going.
Let’s also note that the MCA provider is taking a risk. Sometimes businesses fail despite the cash advance, and you can’t get money back from a failed business. Sometimes the owner of the small business simply refuses to pay back the loan. The higher cost of the deal, then, is built in at the front end to protect the MCA.
A Merchant Cash Advance isn’t for every business.
In fact, it’s probably only useful to a small subset of business owners. Most people may rely on a traditional bank, or a government-backed loan to keep the doors open.
The government is changing the face of the banking industry, making it more difficult to get a traditional loan. It should leave the merchant cash advance providers alone, to ensure that small businesses have the options they need when they need some cash. This is especially true today when people, like the small coffee roasting business in D.C show evidence that small businesses are hurting while the big banks dial back loan instruments to the small businesses who need capital.