Since the turn of the 21st century, a burgeoning new industry has emerged – alternative business loan providers. Traditionally, an entrepreneur would visit a brick-and-mortar bank or a credit union and leave (hopefully) with a small business loan on which he would make set monthly payments. These payments could vary month to month depending on a variable interest rate. Anything else is considered an alternative small business loan. The most important difference in an alternative loan is how it is repaid. Typically, the repayment of an alternative loan is linked to a specific event or based on a specific sale (or revenue event) that raises revenue for the business.
The two expenses most retail businesses must face are:
Operating Costs, i.e., inventory
Overhead Costs, i.e., rent, utilities, advertising, etc.
The one fungible asset that retail businesses have is customers’ use of credit or debit cards. Automated Clearing Houses (ACHs) who process these payments are eager to provide cash advances to businesses that have credit and debit card receipts. Small businesses use these advances to pay operating and overhead costs. Since conventional lenders such as banks won’t fund ailing businesses, alternative lenders have filled the breach to finance viable companies that need capital infusion to turn the corner to success.
Originally designed for businesses receiving a lump sum payment for an agreed upon percentage of future credit and/or debit card sales, merchant cash advances are now defined as small business loans that are repaid in under 18 months. Note, however, that word “loan” has a different meaning depending upon in which state you happen to do business. Regardless of semantics, details of the funding are similar to MCAs.
As constructed from revenue of future credit/debit card payments, MCA companies fund businesses for a cut of the daily credit card income. They work directly with the ACH that processes the card payment. This is why many ACHs have expanded into MCAs. The MCA company will collect remittances from the daily card purchases until the obligation has been fulfilled. Typically, payments are drawn from the card-swipe terminal of the business.
Since these cash advances are based from a percentage of future business sales, they are not loans – and therefore are not covered by a state’s banking laws. One of the advantages of a MCA is that repayment can fluctuate directly with sales volume of the business. This flexibility can
help a business to better cope with slow or off seasons. Also, MCAs are processed more rapidly, giving the recipient quicker access to funding.
An automated clearing house is an electronic network that processes credit and debit transactions, usually in high volume batches. Based on future sales and a fixed fee, an ACH can provide MCAs structured from daily credit/debit card swipes until the advance is repaid. Unlike bank loans, usually there is no set time period for repayment of an ACH.
One advantage of a cash advance from an ACH is that they consider the inherent performance of sales from a business rather than the personal credit rating of the owner. Armed with sales information, they can offer funding based on more relevant data than the information a bank loan committee considers.
Banks consider a number of businesses “high risk.” In fact, the Federal Financial Institutions Examination Council (FFIEC) has compiled a manual with North American Industry Classification System (NAICS) codes that categorize so-called high risk businesses. Casual observers might be surprised to learn that most retail (cash-intensive) businesses are deemed high risk, including convenience stores, restaurants and retail outlets (NAICS 61607). This code also encompasses auto/boat/plane dealerships, jewelers and precious metal dealers and professional service providers such as lawyers and accountants.
With so many businesses categorized as high risk, it’s small wonder that MCAs have filled the breach for financing small business entrepreneurs. In 2011, a Pepperdine University study found that banks declined 60% of small business loan applications. With the enormous obstacles traditional lenders have created, many small business owners have few options other than to seek a MCA.
There are three repayment options of a MCA:
Split Withholding – the ACH splits the credit/debit card sales between the business and the financier at a pre-agreed percentage (usually 10 – 22%). This is the most prevalent option today in the industry.
Lock Box or Trust Bank Account Withholding – All credit/debit card sales are deposited into the finance company bank account; the agreed percentage is then sent to the business via ACH, wire or electronic fund transfer (ETF). Since there is a delay of at least one day for the business to receive its funds most merchants prefer an alternate method.
ACH Withholding – If the MCA repayment is structured from sales, the financier receives the credit/debit card processing data and deducts its percentage directly from the checking account of the business via ACH. If structured from a loan, the financier debits a daily fixed amount unrelated to business sales.
A startup is typically defined as a business in operation for less than two years. Due to its lack of history, funding is usually difficult to secure; hence, growth and expansion can be limited. There is a variety of needs for startup funding including working capital, payroll, equipment and overhead expenses. Unlike most alternative financiers, 1st American Merchant Funding supplies capital to startups.
We offer more flexibility than banks when structuring repayment. Using receivables financing, factoring and private equity, we can structure a package that will serveyour business capital needs as well as addressing cash flow issues. Contact one of our financial consultants today to see how we can help your business achieve success.