Since 2008, the big banks have gotten much bigger. As that is happening, many small banks are disappearing, either being swallowed by the big ones or simply going out of business.
The Washington Business Journal reported on November 23, 2018 in a piece titled “The disappearing bank branch: Fewer branches mean fewer loan options and fewer options for small businesses,” that Candy Schibli is building a coffee roasting business in D.C. and she has found that securing a traditional bank loan was “way more frustrating than the real estate search.” As a result, she is looking at “online lenders, grants and even a private financing round for her growing coffee business.” Options for small businesses are being restricted and alternative providers of capital have become the option of choice for many.
The restricted options for small business are largely the result of federal policies that were supposed to protect consumers from risk. The new regulations, mostly implemented as a result of the Dodd/Frank legislation, are much more expensive to comply with, and only the biggest banks can afford to try. It’s ironic that policies aimed at protecting consumers ended up limiting their choices. But that’s exactly what’s happened.
The consolidation is creating a problem for small businesses across the country. As banks get bigger, they are less interested in helping boost Main Street companies that don’t bring big dollar amount of reserves stored in bank accounts. Owners of small operations, the sort that exist from week-to-week or even day-to-day, are being forced to fund themselves.
Luckily, there are alternatives, such as the merchant cash advance model. The corporations that promote this concept have thought it wise to form a trade association, the Commercial Finance Coalition, to promote best practices that reduce the concerns of local, state, and federal regulators who want to make sure that self-policing is taking place. With every new, innovative model of providing capital to small businesses, there is an educational curve to help politicians understand the great value of increased access to needed money for so many small businesses who don’t want to use a slow, paperwork-intensive way to access needed funding.
The concept is here is simple: a merchant needs some cash — quickly — and an MCA provider makes it available. Now, this isn’t a traditional loan, as from a bank or even a wealthy relative. Instead of charging interest, a merchant cash advance provider may instead take a stake in the company. In return, it gets paid back and may get a share of future returns, depending on the terms of the agreement.
The cash advance is usually just a short-term agreement, so you can think of it like renting a hotel room.
If you plan to live in a city for 30 years, using a traditional mortgage to buy a house makes sense. If you plan to live in a city for a few years, a year-to-year rental of an apartment makes sense. But if you’re only staying in a city for a few nights, a hotel room is a better option. Yes, it may cost $100 a night, which would be $36,000 per year. But if you’re only staying a short time, it’s well worth it. Same with renting a car for a day or two.
The business owners that turn to this model understand the concept. They aren’t dummies; in fact, they’re expert negotiators who have experience dealing with suppliers, employees, and lenders. These company owners understand they’re entering an agreement that may cost them more than a traditional loan would.
Yet they know that these deals are perfect for businesses that have a sudden, unexpected expense. Maybe the delivery truck breaks down, and they need to get their products out right away. Or maybe they need to repair a leaky roof before their merchandise is destroyed. Or perhaps they’re running a seasonal business and need to maintain some cash flow through lean months. Another problem is the recently restricted options for traditional small business loans as experienced by Candy Schibli and her coffee roasting business.
In any case, successful business owners across the country are entering into these types of agreements. That alone highlights the importance of maintaining this business model. It’s a step that some successful people take, sometimes, to keep their success going.
Let’s also note that the MCA provider is taking a risk. Sometimes businesses fail despite the cash advance, and you can’t get money back from a failed business. Sometimes the owner of the small-business simply refuses to pay back the loan. The higher cost of the deal, then, is built in at the front end to protect the MCA.
A merchant cash advance isn’t for every business. In fact, it’s probably only useful to a small subset of business owners. Most people may rely on a traditional bank, or a government-backed loan to keep the doors open.
The government is changing the face of the banking industry, making it more difficult to get a traditional loan. It should leave the merchant cash advance providers alone, to ensure that small businesses have the options they need when they need some cash. This is especially true today when people, like the small coffee roasting business in D.C show evidence that small businesses are hurting while the big banks dial back loan instruments to the small businesses who need capital.
Michael Busler, Ph.D. is a public policy analyst and a Professor of Finance at Stockton University where he teaches undergraduate and graduate courses in Finance and Economics.