By Mike Landau
Merchant cash advance companies and ISOs offering the product are sometimes viewed unfavorably. The high interest charged to business owners for providing them unsecured, high-risk advances is the culprit of this bad press. Well, I firmly believe cash advance is not a bad thing, and not all those who offer it are bad people. In fact, I maintain that the cash advance industry is a great thing, especially in this economy.
As we all know, the current U.S. economic environment is less than friendly to borrowers seeking to obtain traditional forms of financing. We are obviously in the midst of a major market correction; depending on who you ask, it may take anywhere from two to five years to regain market stability and the economic growth we experienced prior to the subprime mortgage and housing market meltdown. So what are small business owners to do when they need to procure financing for day-to-day expenses, expansion, renovations, opening a new location or any of the umpteen things businesses require funding for? Two years ago they could have simply walked into their local bank and filled out a two-page line of credit application. As long as their Fair Isaac Corp. score was within reason, they would be approved within a week.
Unfortunately, times have changed, and even business owners with stellar credit and long-standing banking relationships are being turned down for much-needed funding. In essence, business owners have two choices: put plans for expansion and other goals on hold until traditional financing can be obtained or seek alternative forms of financing.
Most merchants have already exhausted the "friends and family" sphere for start-up costs or other business needs. And angel investors may be hard to come by. As such, cash advance provides an excellent venue for venerable small business owners to acquire the financial infusion they need. The application process to attain a cash advance is simple, straightforward and requires minimal effort on behalf of merchants. The approval process is swift. A decision can be made within days of signing the application. The funding merchants receive can be wire transferred into their accounts via automated clearing house within a week of the application's submission. There are no personal guarantees - if merchants are not committing fraud - to be concerned about.
So, if the investments merchants make toward their businesses don't pay off and they are forced to shut down their operations, they will not be pursued personally by cash advance funders. Furthermore, the factor rate associated with the advance does not compound like interest would on a conventional loan. Some consider the factor rate to be high. But if you take into account the current economic conditions, lack of available lenders, the nonrecourse and speed with which the advance can be processed, it's a pretty good deal.
For example, an ice cream vendor contacted us for the purposes of an advance at the beginning of the summer. The merchant was seeking an advance to purchase a new awning that would facilitate placing tables outside her store, thus increasing the amount of people she could seat. The advance was not a large sum of money, but it was enough for her to complete the improvements she was looking for to take her business to the next level.
I got a call from her a few weeks later informing me that not only had the awning increased the amount of people she could seat, it had increased her profits by 35 percent. She felt the awning attracted additional foot traffic to her store. She immediately asked me if it would be possible to obtain an additional advance in order to purchase a frozen yogurt machine. This merchant is a perfect example of how a cash advance enhanced her business and increased her revenues. Another example is an application we received from a Midwest merchant who had an existing line of credit and a quality banking relationship. His credit was good, and he had been a great customer of the bank for over 10 years. You can imagine his shock when he received notice in the mail that his $250,000 line of credit was to be terminated within 14 business days. The only reason the bank furnished him with was that, based on the current economic climate, they could no longer keep his credit line outstanding. He was faced with the choice of going out of business, taking on an equity investor or receiving a merchant cash advance.
He weighed his options carefully and, after running the numbers, felt it made significantly more sense to opt for the cash advance as opposed to "getting married" to an equity investor.
The cash advance enabled him to restructure the way he purchased inventory and set his business on firm ground for the future. These are just two examples of how unsecured funding, although expensive, assisted merchants in both enhancing their business and empowering them to continue operations. While they paid a high factor rate, the overall long-term benefit of the influx of capital greatly outweighed the cost of the funds.
With the recent demise of Lehman Brothers Inc. and the buyout of Morgan Stanley, the credit markets are going to become even tighter. It is my opinion that even merchants with stellar credit histories are going to find it difficult to obtain financing over the next several years. From a lending perspective, the major financial institutions haven't yet begun to adjust to the current credit climate other then declining a large percentage of applications that come through the door.
This will further make the case for the cash advance industry to become more mainstream and part of the norm for small-business financing. Some unscrupulous ISOs and cash advance providers in the industry exploit merchants who are desperate for much-needed funding. These villains hit merchants with a slew of fees that well exceed normalcy. However, they are the exception. Most of the major funders believe the factor rate provides for adequate profitability.
As long as merchants adhere to best practices, the merchant cash advance industry is an alternate form of financing that can do wonderful things for small business owners and their bottom lines.
Mike Landau is President of MaxAdvance in Brooklyn, N.Y. You can reach him via e-mail at firstname.lastname@example.org or by phone at 212-405-1980, Ext. 201.
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