Controversial Merchant Cash Advances Come at a High Cost for Small Businesses

A bunch of businesses in southwest Chicago.

Short term financing known as cash advances to traders puts some small businesses in financial hot water.

Marketed as a quick way to access cash, cash advances from traders can help some entrepreneurs get out of a tough spot, but consumer advocates and government officials say all too often it’s done. is not the case.

Here’s how they work: typically offered by credit card processing companies, a 24/7 cash advance from the merchant is a lump sum got out as an advance on a borrower’s future sales. Typically, the borrower then repays this balance – plus a large premium – through automatic deductions from their daily credit or debit card sales. or the company’s bank account.

Woodstock Institute, a nonprofit research organization, has analyzed a number of merchant cash advances and found that borrowers often end up paying effective interest rates that can reach triple-digit percentages.

In one case, a supplier gave an advance of nearly $ 24,000 to a company, charge over $ 1,100 in fees for things like issuance of advance, risk assessment and processing. To collect his payments, he deducted $ 499 per day from the company’s sales for 76 days.

In total, the borrower paid nearly $ 37,500 – paying an effective interest rate of about 346%, according to Spencer Cowan, executive research consultant for the Woodstock Institute. Cowan testified about this before a Senate banking committee in January.

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If companies can’t keep up with payments, things can go wrong quickly, said Eric Weaver, CEO of Opportunity Fund, a community development financial institution, or CDFI, based in San Jose, Calif., that provides loans to small businesses and individuals in low-income communities. CDFIs are certified and supported by the US Department of the Treasury.

Automatic deductions will continue as long as there is money to be withdrawn for the cash advance company. Many business owners take out new advances to pay off outstanding balances on previous advances, plunging them into a cycle of debt.

“Many go bankrupt,” Weaver said.

Joe Ruvacalba, a Latino entrepreneur from Rancho Cucamonga, Calif., Started his own plumbing business four years ago with just $ 10,000. But cash flow quickly became an issue.

“You start a job, but your first customer check might not come for 30 to 60 days. But you still have to pay for labor, materials and everything,” he said.

None of the banks gave him a loan, so he resorted to a merchant cash advance. The first was $ 50,000, on top of which he said he paid an additional $ 20,000 in fees and other charges.

“I had to pay that one back in six or seven months,” he said.

Without being able to get a business loan from a bank, Ruvacalba said the only way for him to grow his business, keep his salary expenses under control and repay his previous cash advance was to get more money. cash advances from traders.

“At one point we had five of these loans,” he said. “And I remember we were paying around $ 5,000 a day.”

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In total, Ruvacalba took $ 700,000 in cash advances from traders, which cost him around $ 200,000 in fees and interest.

“As a landlord, you have to ask yourself, ‘Can I handle this payment every day? “And if you can’t, don’t get it,” said Ruvacalba, who paid off the advances in four years.

Despite what it cost him, Ruvacalba does not regret his decision. “I’m not going to criticize someone who was ready to help me when the banks weren’t,” he said.

Obtaining traditional loans from banks has been a particularly difficult problem for black and Latino business owners, said Lauren Stebbins, senior partner for small business initiatives at Opportunity Funding Network, a non-profit association educate small businesses on financing alternatives.

terry bagget
After struggling to get a loan, Terry Baggett, owner of Chicago-Springfield Insurance, took a cash advance to a merchant.

“Black and Latino businesses are credit refused by banks at a higher rate than white-owned businesses, so they opt for alternative financial products that offer easy and quick financing, ”said Stebbins.

The problem is that advances are not regulated by the government and fees, penalties and rates are not subject to any control. In addition, the terms of the advance are not always clearly defined and the total amount due – including high fees and charges on top of the initial advance – is usually not expressed as an annual percentage.

“They may not know what they are getting themselves into because these vendors are not required to disclose their terms,” Stebbins said.

Related: America Missing $ 1.4 Trillion Latin Business Opportunity

Another problem: After a business owner takes a lead, he is often bombarded with offers for more.

coconut financing

In early 2015, Chicago Mayor Rahm Emanuel denounced merchant cash advances in a press release, noting that providers have “ramped up their marketing efforts, which has led many small businesses to take out loans that ‘they can’t afford. The city also unveiled two city-sponsored loan alternatives for community businesses.

Terry Baggett, an African-American entrepreneur who owns Chicago-Springfield Insurance in the Humbolt Park neighborhood, where his family has operated for 50 years, first took out a cash advance of $ 12,000 to a merchant last year. Since taking the advance, he has received calls every day offering new advances.

“They are throwing money at me,” he said. “A guy from Coconut Funding said I could buy a boat with it.”

CNNMoney contacted the Honolulu-based company Coconut financing. A man who identified himself as the president of the company declined to comment for this story.

Baggett pays $ 180 a day to repay his advance and says he’s not planning on getting another one.

“In the long run, you have to see how much money comes out,” he said. “I hope that once my cycle catches up, I don’t even have to deal with these guys anymore.”

CNNMoney (New York) First published on December 1, 2016: 8:35 a.m.ET

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