Firms Turn to Riskier Financing
Firms Turn to Riskier Financing
No Assets? No Problem! Hit hard by the last several years of a slow economy, the number of small businesses seeking credit is on the rise. Rejected in the lending line by banks and other commercial finance options, businesses with fewer assets or collateral are turning to the cash advance industry for quick money….expensive money. Despite the high cost – up to 104% to 177% annualized – small businesses are willing to pay these rates just to keep their doors open. The cost seems a small price to pay for the ability to get a cash advance quickly and with relatively little paperwork or guarantees required. Asset based lending can be much a much less expensive alternative, with rates ranging from 4% to 20%, depending on several variables. It is worth exploring prior to paying the high rates associated with a cash advance.
Source: CNN Money.com, February 21 2012, by Jose Paglieri
Banks denying small businesses loans keep demanding what they can’t have – collateral – and the disconnect is forcing firms to look elsewhere.
Small businesses are caught up in the collateral crisis, as banks continue to focus on healthy credit scores and tangible assets like property, two of the hardest hit casualties of the recession. “A lot of the traditional collateral that entrepreneurs used to have disappeared,” said Ami Kassar, a financing consultant and CEO of MultiFunding. It’s a quandary long in the making. The landscape of U.S. small firms has changed from manufacturers to service companies, yet banks keep demanding collateral like equipment and land. The chasm has produced a breeding place for others, according to FOCUS investment banker John Slater.
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“Banks have backed away from making loans at a time when what many businesses have of value is cash flow and not physical assets,” said Slater. “That’s created a market opportunity for the cash advance industry.” Those in the trade, such as AmeriMerchant and RapidAdvance, offer quick money with a hefty fee. Typical clients are restaurants and small shops, which take out advances that range between $5,000 and $200,000. A business owner who takes out a $70,000 advance will have to pay back $100,000. Lenders ensure repayment by immediately taking a fixed portion, close to 15%, of a sale every time a customer swipes a credit card at the shop. Advances commonly take six months to repay and carry annualized interest rates of 104% to 177% if paid evenly every month, according to a 2009 industry analysis by consulting firm First Annapolis. Marc Abbey, an expert and managing partner at the firm, said figures are similar today.
Despite complaints that such terms amount to predatory lending, the industry is supported by some small businesses that revel in how easily advances are made. Financing firms require little paperwork and no collateral or guarantees.
It’s a merchant cash advance that kept open The Killarney, an Irish pub in Vermont that feeds those coming down from the snowy Okemo Mountain Resort. During the restaurant’s first year in 2005, owner Mark Verespy exhausted a $285,000 Small Business Administration loan to buy the place and burned through a $50,000 line of credit. He needed more, but the bank denied him. Verespy’s kitchen equipment was not enough. “They were looking for my parents to put their house up and all kinds of stuff that were just not an option,” said Verespy. Instead he turned to Merchant Cash & Capital, which analyzed the pub’s cash flow and quickly handed over $30,000. Verespy has returned to the company a dozen times since. “It’s not inexpensive,” he said. “But the good side is, if I need funding I can generally get it in less than a week. If I had to wait for the bank to get a loan, I’d probably be out of business.”
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Large financial institutions that have long sat on the sidelines are starting to listen. In September, American Express (AXP, Fortune 500) began offering a similar option it calls “express merchant financing.” Raja Sengupta, an executive who oversees the program, said it’s different from merchant cash advance, because it’s only offered to existing business clients who show a strong enough flow of customers using American Express credit cards. Zalmi Duchman, CEO of TheFreshDiet.com, turned to American Express after three banks denied him loans and found the financing terms of his credit card processor unfavorable. Duchman was looking for quick money to finance an ad campaign for his food operation in Miami Beach.
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His credit card processor offered $1 million if he would pay back $1.15 million by giving up 8% of every customer’s Visa and Mastercard payment. “When I looked at it, I said, ‘It’s loan shark money,’ ” said Duchman. American Express offered him $750,000 with a fee equivalent to a 6% annualized interest rate. He said 10% of every payment customers make with an American Express card goes to pay down the $795,000 bill. Unlike a bank loan, however, the full amount must be paid back by year’s end or American Express will claim all of every future credit card receipt. Still, he happily accepts the cost and risk. “I have to give American Express props for entering this business,” Duchman said. “They’re doing what the banks and SBA aren’t doing, and that’s giving out money. It’s hard to demonize them.”