The United States is now nine years into one of the longest continuous stretches of economic recovery and yet access to working capital remains stubbornly out of reach for the majority of small businesses. Though repeatedly referred to as the so-called “backbone” of the American economy, small business owners have found themselves mostly ignored and on the sidelines while large corporate profits have soared and money has flowed freely between the big banks and big business. Adding insult to injury is the low interest rate environment that has endured since the financial crisis. Money is cheap but only for those who need it the least.
“In July, America's large banks denied three in four small business loan applications,” writes Walter Myers III is a recent op-ed for Investor’s Business Daily. “Community banks were just a touch more generous.” In fact, even the community banks approved less than half of all applications. It’s why the Merchant Cash Advance (MCA) continues to thrive despite pushback from regulators in certain states and an overall wariness among consumers.
Such wariness is well-founded considering the number of bad actors and negative press MCA’s have received over the past decade. Some of the press equating MCA’s to personal payday loans has been a bit unfair, as the right MCA provides needed liquidity to small businesses that are unable to secure a business loan. However, some of the negative press has been justified, as there are still a slew of brokers and lenders that prey on weak applicants and crush them with upfront fees and egregious rates. These lenders hope to recoup enough of their funds to make a healthy profit on the loan even if the recipient winds up defaulting in the long term.
A Merchant Cash Advance differs from a traditional business loan in three major respects. The first is that it is a loan against future expected revenue, or cash receipts. The most notable differences from the borrower’s perspective are that rates tend to be much higher than traditional loans and the terms are much shorter. It’s not uncommon to see double-digit rates (if you were to annualize the cost of funds) and terms as short as six months. Perhaps the biggest difference, though, is that the payback funds are typically withdrawn in daily or weekly increments.
MCA’s are designed to provide a quick fix for businesses struggling with temporary cash flow issues, to offer liquidity for seasonal businesses or give the ability to purchase equipment or expand a business on short notice. The upside is that approvals are easier to come by and, with financial discipline, business owners can pay them off in a relatively short time-frame, often before the stated term. Nevertheless, warnings abound because the ease of acquiring these funds and the small daily payments can sometimes lull a business owner into thinking they can afford to borrow more than their cash flow can handle. So it’s imperative to know exactly how much one can afford to pay back under the worst case scenario, not most optimal.
As the industry matures, niche players continue to find ways to provide financing to cash-strapped business. It’s a positive step in the MCA world because competition is increasing and consumers have more options. The most recent entrants on the lender side are payment processing companies and tech companies that possess great technology, already have existing relationships with many borrowers and happen to have enormous balance sheets.
One of the more notable examples is a recent partnership between Airbnb, the global home rental giant, and AirAdvance, which provides Airbnb hosts with access to funds advanced against future bookings. Airbnb isn’t the only digital giant getting into the MCA game. Shopify, one of the leading e-commerce platforms in the world established Shopify Capital in 2016 to help online retail customers procure financing. According to their 3rd quarter 2018 earnings report, “ Shopify Capital issued $76.4 million in merchant cash advances in the third quarter of 2018, an increase of 73% versus the $44.1 million issued in the third quarter of last year. Shopify Capital has grown to nearly $375 million in cumulative cash advanced since its launch.”
A recent article in Tech Crunch indicated that Stripe, one of the fastest growing online payment processors, is also considering adding MCA to its offerings, following in the footsteps of competitors Square and PayPal. According to the article, “Issuing business loans, in that regard, also would help Stripe compete better against the rest of the payments and financial services pack, including other tech-first companies like Square and PayPal, more established payment and credit firms like American Express, and of course traditional banks.” According to Tech Cruch, Square Capital “facilitated over 60,000 business loans totaling $390 million, up 22 percent year over year.”
It’s important to remember that this is still a fledgling industry. Over the next decade the industry will continue to refine and mature and regulators will begin to get a deeper hold on the market and hopefully offer greater protections. In the meantime, it behooves borrowers to acquire as much knowledge as possible and stay focused on the bottom line of their businesses.