Access to capital is what makes a business stand out in today’s difficult economic environment. Many small businesses have experienced a dramatic drop in sales and cash flow, some to the point where they closed their doors. However, large U.S. corporations have been able to grow sales, open new retail outlets, and increase earnings per share. Small businesses almost always rely on traditional commercial bank financing such as SBA loans or unsecured lines, while larger publicly traded corporations have access the public markets such as the bond market and stock market for capital access.
Many of the biggest U.S. banks had an open lending policy to small businesses prior to 2008’s financial crisis and subsequent Great Recession. These business loans included unsecured lines of credit, installment loans and loans without collateral. The loans were almost always backed by a personal guarantee from the business owner. To virtually guarantee approval of a loan for a business, you only needed to have good credit.
These business loans and lines were used by thousands of small business owners to finance working capital requirements such as payroll expenses, purchases of equipment, maintenance and repairs, marketing and tax obligations, expansion opportunities, and other costs. Many small businesses were able to thrive and manage their cash flow as they arose because they had easy access to capital resources. Many business owners became too optimistic, and made more risky bets than they could afford.
Many business owners became ambitious and began to borrow heavily from small business loans and credit lines in order to expand their businesses. They hoped to be able to repay these large debts through future growth and higher profits. Banks maintained an ‘easy money’ policy. Asset values soared, consumers spent more, and business owners expanded with increased leverage. This party would eventually end abruptly.
The 2008 financial crisis began with Lehman Brothers’ sudden collapse, which was one of Wall Street’s oldest and most respected banks. Financial panic spread quickly throughout the credit markets. The credit markets were shut down and the financial system in the United States was unable to function as normal due to the resulting freeze. The sudden shortage of easy money caused banks to stop lending overnight. This had caused asset values to rise in recent years, particularly home prices. Now, those same asset values are plummeting. Asset values collapsed, and commercial bank balance sheets became less healthy. Stock prices also fell. The days of easy money were over. Officially, the party was over.
The Great Recession, which followed the financial crisis, created a vacuum on the capital markets. Even the same commercial banks that had lent money freely to small businesses and owners of small businesses, were now facing a crisis in their capital balances that threatened their very existence. Many commercial banks stopped granting further credit to small businesses and called due any outstanding business loans. These business lines of credit were essential for small businesses. Without it, they could not meet their cash flow requirements and fulfill their debt obligations. Many small businesses were unable to handle a sudden drop in revenue and sales.
Many of these small businesses are responsible for creating millions of jobs. Every time one of them fails, the unemployment rate rises. The financial crisis grew worse and commercial banks fell into a spiral that threatened to endanger the entire financial system. The damage was done, even though Congress and the Federal Reserve Bank led a tax payer-funded bailout of the entire bank system. To prop up the banks’ balance sheets, hundreds of billions were spent to bail out what were effectively bankrupt institutions. During this time, however, there was never a provision that required banks to lend money to consumers or businesses.
Instead of using some of the taxpayer funds to help small businesses, avert business failures, and increase unemployment, the commercial banks continued to deny capital access to thousands of small business owners and businesses. Even though they received a historic taxpayer-funded bailout, commercial banks continued to deny access to credit lines for businesses and commercial loans to all borrowers, regardless of their credit history and timely payments. The number of small business bankruptcies soared, and there was still high unemployment.
Large publicly traded corporations were able to survive and grow their businesses during this time, even though small businesses were becoming extinct. They could do this mainly by issuing bonds through the bond market or by raising equity through the stock markets. While large public companies were raising hundreds to millions of dollars in new capital, small businesses were being taken under by banks that shut off existing commercial lines and refused to issue small business loans.
Even though it is now mid 2012, four years after the financial crisis began, many small businesses still lack capital access. Nearly all small businesses are denied loans by commercial banks on an unsecured basis. A small business must have tangible collateral that the bank can easily sell to get approved for a business loan or line-of credit. Without collateral, a small business has little chance of getting approved for a loan, even though the SBA does not require collateral.
If a small company cannot provide collateral for a small business loan, the bank will request that the owner of the small business secure the loan using his or her personal assets, equity, or savings. This could include equity in a home or cash in a retirement account such as a pension, 401k, or IRA. In the event that a small business fails, this situation puts the owner’s personal assets at risk. A majority of small business loans require that the owner have good credit scores and FICO scores. They also require a personal guarantee. For almost all small business loans, financial statements that show sustained profitability over many years, including tax returns, will be required.
Failure to meet these requirements can often lead to rejection of applications for small business loans and commercial lines of credit. Many times, applicants who meet all of these requirements are denied business loans. In the current economic climate, approval of a loan request for business purposes is not guaranteed if you have good credit, collateral, strong financial statements, and tax returns. It is becoming more difficult for small businesses and owners to access capital.
Small businesses and owners of small businesses have been looking for alternative sources of capital and loans to finance their operations. Private investors offer small business installment loans and merchant cash advance loans to small business owners who need cash flow to fund expansion or business operations. Merchant cash advance loans have many advantages for small businesses and owners of small businesses, compared to traditional commercial bank loan.
Merchant cash advance loans are sometimes called factoring loans. They are calculated based on how many credit cards a retailer or merchant processes in a period of three to six months. Merchants and retailers that accept credit cards from customers (including Visa, MasterCard, American Express or Discover) are almost guaranteed approval for merchant credit card advances. This average of three to six months determines the amount of cash advance a merchant is eligible for. The funds are usually deposited in the small business checking account within seven to ten days of approval.
The lender approves the advance and sets a predetermined repayment amount. Interest and repayment of the cash advance are also predetermined. If a retailer or merchant processes $1,000 per day in credit card transactions from customers, then the monthly average credit card processing is $30,000. The merchant is eligible for $30,000 cash advance. The factoring rate is 1.20. This means that the total amount to repay is $30,000 plus 20% of $30,000, which equals $6,000 for a total of $36,000. The merchant would be paid a lump sum amount of $30,000, which would be deposited into the business checking account. A total of $36,000 would also need to repaid.
The merchant automatically deducts a pre-determined amount from each merchant’s future credit card sales, usually at a rate 20% of the total daily credit cards processed. The merchant doesn’t have to send checks or make payments. The fixed percent is deducted from any future credit sales until $36,000 is paid. This type of financing is more advantageous than a commercial bank loan because a merchant cash advance does not appear on the owner’s credit report. This effectively seperates the personal and business financial affairs of the owner of a small business from those of the entity.
The second benefit of a merchant cash advance credit card is the lack of a personal guarantee from the business owner. The business owner cannot be held responsible if the merchant cash advance loan is not repaid in full. If a commercial bank loan for business requires a personal guarantee, the owner can remove the financial consequences. This often leads to business owners becoming bankrupt if they are unable to repay the loan amount.
The third and most important advantage of a merchant creditcard cash advance loan is the lack of collateral. There are no additional collateral requirements as the future credit card receivables serve as security for the cash advance repayment. This type of financing is an excellent alternative to traditional bank loans for small businesses that do not have inventory or physical equipment. It also allows for capital access for merchants, sole proprietorships, online shops, and retailers who don’t have the collateral. These businesses would not be eligible for traditional business loans because they lack collateral that could serve as additional security to the lender or bank.
A merchant credit card advance loan approval is not dependent on the owner’s personal credit score. The cash advance will be approved even if the owner of the business has poor credit or a low FICO score. Personal credit of the business owner is not usually examined. This is done to help determine the factoring rate at the loan’s total repayment. A merchant credit card cash advance loan can be obtained even by a person who has just been discharged from personal bankruptcy.
