The Wall Street Journal
By: Angus Loten
August 18, 2011
Facing weak sales and tight credit, some store and restaurant owners are turning to high-cost merchant cash advances for working capital, driving growth in a lightly regulated sector.
The providers say they are filling a financing gap for high-risk borrowers with good earnings, but little or no collateral. There are now more than 40 companies issuing cash advances to small businesses, from just a handful of providers a decade ago, officials at electronic-payment industry firms say.
The companies provide funds to businesses in exchange for a share of future sales and a fixed fee. A company's remittances are drawn from customers' debit- and credit-card purchases on a daily basis until the advance is repaid. Most providers form partnerships with card-payment processors and take payments directly from a business owner's card-swipe terminal.
The cash advances come with added risks. Since the cash advances are technically sales of future assets--rather than direct loans or credit--providers aren't subject to state usury laws or any of the restrictions under the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Glenn Goldman, chief executive of Capital Access Network Inc., which operates the nation's largest merchant cash advance provider by market share--AdvanceMe, says dozens of smaller cash-advance providers that started entering the market in 2006 gave the industry its reputation for aggressive marketing and remittance tactics. "There are few barriers to entry.It's a business that is easy to set up, but hard to grow," he says, adding that many of these start-ups have since shut down.
Janinne Dall'Orto, a manager at First Annapolis, a Linthium, Md., electronic-payments consulting firm, says in recent months the nation's four-largest merchant cash advance providers have been issuing as much as $8 million a month, up from $5 million in 2008, with advances ranging from $50,000 to well over $200,000, she says.
Last week, AdvanceMe reported hitting $2 billion in financing to some 40,000 small businesses since launching in 1998, doubling its total output since the onset of the recession. This month, AdvanceMe expects to issue more than $40 million in advances, and is now on pace to reach $3 billion in total funding within two years, the company says.
Mr. Goldman says access to daily sales data from thousands of businesses has enabled the company to develop better models of risk management and underwriting than most banks, which he says rely too heavily on standard credit-risk scores in lending decisions.
A recent study by Pepperdine University found that banks have denied about 60% of small-businesses loan applications since January.
Still, according to Capital Access Network's own research, small-business owners tend to look to banks first for capital, though only one-third obtain collateral-based loans. At least one in 10 seek nonbank financing options, including cash advances or peer-to-peer loans, the company says.
Unlike a bank loan, there is typically no set period for repayment of an advance, allowing remittances to rise and fall with a company's sales. These advances tend to appeal to businesses with a high volume of daily debit- and credit-card sales, such as retailers and restaurants.
Ken Wisnefski, the former owner and chief executive of VendorSeek.com, an online service that connects companies with business services, says a $200,000 merchant cash advance from AdvanceMe kept his business going at the height of the recession in early 2008.
"We were getting turned away by just about every bank I approached, but within 14 days we got the working capital we needed," says Mr. Wisnefski, who has since sold the company in late 2008 to establish another company in Mount Laurel, N.J. Though charged $50,000 for the advance, he says the funds enabled his former company to grow fast enough to absorb the high fees.. Mr. Wisnefski says he's now looking into another cash advance to cover the costs of hiring more workers for his new business.
"It's still incredibly difficult to get credit, and this option is out there," Mr. Wisnefski says.
Matt Hutchins, the owner of a Cambridge, Md., auto shop R&M Performance LLC, took out a $41,000 cash advance from RapidAdvance in 2008 to buy new equipment. After agreeing to nearly $20,000 in fees, Mr. Hutchins said RapidAdvance "hounded" him for payments when debit- and credit-card sales fell during the recession. Eventually, the company sued the auto shop for a lump-sum repayment of the advance, which he said he paid off to end the matter. "I'll never do that again," he says.
Joe Looney, the general counsel at RapidAdvance, didn't comment on complaints, but said that while there is little regulatory oversight of the sector, cash advance providers often have no recourse when a client defaults. Despite those risks, he said cash advances have "provided billions in capital to small businesses" at a time when bank loans are scarce.
Rapid Financial Services LLC, a Bethesda, Md., firm provides merchant cash advances under the name RapidAdvance.
Mr. Goldman of Capital Access Network says oversight of the industry falls primarily to the courts, which in most cases determines if an advance was handled as a sale or a loan, and whether usury laws apply.
In recent years, the industry has taken steps to police itself. In 2008, 10 of the largest providers created the North American Merchant Advance Association, an industry trade group that has set ethical standards and best practices guidelines. These include clear disclosure of fees, proper payoffs of balances, and a better sensitivity to merchants' cash flow.
"Most of the bad apples were cleaned out of the industry during the recession," says David Goldin, the trade group's president. "We're not hurting merchants, we're helping them."
Robert Day, CEO of Merchant Relief Council LLC, a Tustin, Calif., consulting firm, says small-business owners should think twice about taking a cash advance simply to fill gaps in cash flow.
Write to Angus Loten at firstname.lastname@example.org