The ABCs of Merchant Cash Advance
“There is an $ 87 billion small business financing gap,” said Marina Linhart, CEO of Next Street. The firm advises cities, foundations, large institutions, lenders, and nonprofit organizations that serve small businesses on how to do it best.
Undercapitalized companies have lower sales and profits, generate fewer jobs, and are more likely to fail. Evidence shows that female entrepreneurs are deterred from applying for credit, seek less finance than men, are approved less often, and pay more for credit. The key to closing the gap “is to have access to the right form of capital in the right amount that is needed”. Linhart noted. “Alternative finance provides a very useful product for very specific circumstances for businesses.”
The good news is that there is an array of new financing options that are now available, but also those that have been around for years. The bad news is that the abundance of options can be overwhelming for the entrepreneur. Even if you have consulted a professional, it is essential to understand why certain options are expensive but may still be suitable for your situation.
Factors such as being a startup, having irregular cash flow, needing money fast, not having a good credit rating, not having collateral, and wanting a straightforward application process should weigh in on your decision. As clothing retailer Sy Syms put it, “An educated consumer is our best customer.” What is valid for the purchase of clothing is even more true for financing.
A small percentage of growing companies will raise angel or venture capital, but even they should know about non-dilutive financing options, so as not to give up too much of their business. When investors own stock in your business, you may need to consult with them on how you run your business. And finding the right investors can be time consuming. Lenders and most alternative lenders do not take ownership of your business. They don’t have a say in how you run your business. However, you have to repay the money within a set time frame, so having cash is essential.
“Merchant cash advances have been around for decades,” said Christine Chang, CEO of 6th Avenue Capital. She has spent her 25-year career in the alternative credit industry with companies such as Charles River, Credit Suisse and New York Private Bank & Trust. The merchant cash advance (MCA) is not technically a loan; it gives you an initial sum of money in exchange for a portion of your future sales, such as credit card / debit card sales. Or the Automated Clearing House (ACH) advance, which uses a small business’s bank deposits and cash flow from bank statements to determine funding and repayment. The money is refunded on a fixed daily or weekly schedule. It is a good source of short term funding (12 months or less). 6th Avenue Capital uses technology to help its underwriters be more efficient in their due diligence process, but it also interviews entrepreneurs to understand their personal stories.
MCA and ACH advances are expensive. This is a form of capital that has been associated with predatory lending, which is unregulated and unsecured finance, Chang commented. “We have a policy of radical transparency on the total cost of capital. Our average factor rate is between 1.25 and 1.5, with an average of 1.32. For every $ 100 that a small business receives, it pays $ 32 for the use of the money during the prescribed period.
Because the industry is unregulated, “we really do a lot of self-regulation,” she said. While 6th Avenue Capital would favor regulation to eliminate bad actors, it also recognizes that sometimes regulation can hurt the voters it is trying to help. The Dodd-Frank law enacted in 2010 had the unintended consequence of making small business loans less profitable. However, even before that, small business loans were in decline. The big banks have focused on lending to medium and large companies, and some small banks have closed their doors. As a result, the company is a member of the Independent Lending Platform Association and the Small Business Financial Association. Both organizations are active lobbyists on Capitol Hill, defending the interests of small businesses and lenders.
When you are not a bank, marketing to small businesses for financing is an expensive endeavor. It may sound counterintuitive, but 6th Avenue Capital has strategic partnerships with other small business financiers. When a small business doesn’t match a bank loan or credit union, it refers to other reputable lenders. For this reason, other alternative financing options refer to each other. Industry specialists and associations also make references. And, finally, mission-based organizations like Next Street make referrals.
When entrepreneurs need short-term financing quickly – 24 to 48 hours – an MCA or ACH advance can be worth the cost. Various companies use this type of financing to fill the gap:
- During the federal government shutdown, when the SBA loans stopped flowing.
- When a fleeting opportunity to buy expensive kitchen equipment at a great price presented itself at a restaurant.
- When a skincare startup received a big order from an awesome retailer and couldn’t benefit from traditional invoice factoring.
- After Hurricane Harvey wiped out Houston, a construction company needed quick equipment to help the city rebuild.
- When a home-based e-commerce business needed to stock up for the holiday season and didn’t qualify for traditional factoring.
It’s important to note that once your business has grown and established its repayment capacity, it can increase the credit stack to cheaper sources of capital.
When seeking funding, be prepared. You need to decide if you need to raise capital (and how much), what you will use it for, and for what period of time you will spend it. How fast do you need money? Determine your financing needs by estimating the associated costs for that particular phase of your business. Also estimate the income. Do a monthly cash flow analysis. This analysis will highlight the period for which you need external financing. Find out what all of your financing options are.
What types of financing are you considering?