When small busi­nesses in need of quick cash end up with a pile of high-in­ter­est debt

Pittsburgh Post-Gazette - - Business - By Tim Grant

Natalie Bobak didn’t an­tic­i­pate how much money would be go­ing out the door as she strug­gled to get her ba­con-themed restau­rant called Porked off the ground.

She busted her bud­get more times than she imag­ined she would in the first few months try­ing to keep up with all the ex­penses. There was rent and over­head on the build­ing in Lin­coln Place, equip­ment to buy, em­ploy­ees to pay, and she al­ways had to keep a fresh sup­ply of the food.

“If you are try­ing to build a brand like I’m do­ing, it has to be per­fect,” Ms. Bobak said. “It can’t be fly­ing by the seat of our pants — ever.”

Within four months of open­ing her restau­rant in Oc­to­ber 2017, she hit a cash flow crunch. She needed a few thou­sand dol­lars for op­er­at­ing ex­penses. She couldn’t wait months for a tra­di­tional bank to ap­prove her loan ap­pli­ca­tion. She didn’t even have weeks to spare.

Like many small busi­ness own­ers that find them­selves in a bind, she turned to an al­ter­na­tive form of busi­ness fi­nanc­ing called mer­chant cap­i­tal.

“They look at your sales. You send them your bank state­ments and they come up with a loan amount,” Ms. Bobak said.

Later she would re­gret that de­ci­sion.

A newer form of fund­ing

The mer­chant ad­vance in­dus­try is a rel­a­tively new form of fund­ing for small busi­nesses. It has thrived in light of the chal­lenges that many small ventures ex­pe­ri­ence when seek­ing tra­di­tional bank loans. Mer­chant ad­vances are fast and easy, even if they can be ex­pen­sive.

So many new firms have en­tered the mar­ket­place that some in­dus­try ob­servers see the warn­ing signs of a bub­ble. Ac­cord­ing to MoneyThumb.com, as of May there were more than 1,000 mer­chant ven­dors across the U.S. and mer­chant cash ad­vances pro­vide $5 bil­lion to $10 bil­lion each year to small busi­nesses.

The in­dus­try is also evolv­ing. It used to be only busi­nesses that ac­cepted credit cards were el­i­gi­ble for a mer­chant ad­vance. Now busi­ness that use ACH have be­come el­i­gi­ble as well. ACH pay­ments are elec­tronic pay­ments made through the Au­to­mated Clear­ing House net­work. Funds move from one bank ac­count to an­other with the help of an in­ter­me­di­ary.

Mer­chant loans go by sev­eral dif­fer­ent names — mer­chant cash ad­vance, mer­chant cap­i­tal, mer­chant fi­nanc­ing or sim­ply cash ad­vance.

The type of small busi­nesses that rely heav­i­est on mer­chant cash ad­vances are restau­rants and re­tail stores, which have sig­nif­i­cant ups and downs in their cash flow; and sa­lons and auto re­pair shops, which usu­ally ser­vice a heavy vol­ume of credit card pay­ments.

Credit card pay­ments play an im­por­tant role in the mer­chant cash ad­vance busi­ness.

The mer­chant ad­vance com­pa­nies pro­vide small busi­ness own­ers with cash to run their busi­ness. In re­turn, the busi­ness own­ers al­low the mer­chant lender to tap into the com­pany’s bank ac­counts and daily credit card rev­enues.

Data in play

Kab­bage, an At­lanta-based mer­chant lender that started do­ing busi­ness in 2011, is one of the largest play­ers in the in­dus­try. The com­pany said it has pro­vided over $8 bil­lion in cap­i­tal to more than 200,000 busi­nesses in all 50 states.

Laura Gold­berg, chief rev­enue of­fi­cer for Kab­bage, said the com­pany pro­vides credit lines for up to $250,000. She said the com­pany is able to make fast lend­ing de­ci­sions due to its data-driven plat­form that looks at real-time busi­ness data.

If the com­pany sells prod­ucts on­line, she said Kab­bage can link to Ama­zon, eBay and Face­book

ac­counts and pull data to make a credit de­ci­sion.

“In­ter­est rates are de­ter­mined uniquely for each cus­tomer,” Ms. Gold­berg said. “We al­low our cus­tomers to com­pare fa­mil­iar an­nual rates, but since we of­fer ac­cess to short-term loans with monthly fees, we also pro­vide ex­act dol­lar amounts each loan will cost. We call it to­tal cost of cap­i­tal.”

She added, “It’s a monthly fee-based loan, and fees vary based on the cus­tomer.”

She said the monthly fee ranges from 1.5% to 10% each month.

The com­pany be­lieves the rates it charges small busi­nesses are fair. “Our cus­tomers come back and take more loans,” she said.

Reg­u­la­tors on the look­out

Some ad­vise that busi­nesses should be care­ful when seek­ing fund­ing through a mer­chant ad­vance, some­thing that can be chal­leng­ing when the need for quick cash hits.

Bank­ruptcy at­tor­ney Matthew Her­ron, owner of Her­ron Busi­ness Law in Shady­side, said lend­ing arrangemen­ts of­fered by some com­pa­nies of­ten sound like a tra­di­tional loan, but they are not. In­ter­est rates on cash ad­vances can some­times ex­ceed 400%, he said.

“Legally, they don’t clas­sify this as a loan,” said Mr. Her­ron, who is Ms. Bobak’s at­tor­ney. “That’s how they can get around usury laws where they can charge un­re­al­is­tic in­ter­est rates. They call it a mer­chant cash ad­vance. They call it a re­ceiv­ables pur­chase. They call it mer­chant fund­ing.

“But in re­al­ity it is a very high-in­ter­est loan,” he said. “The prob­lem here is they don’t tell you when you get these loans is most busi­nesses can’t sur­vive it.”

Some fed­eral and state reg­u­la­tors are tak­ing a look at the in­dus­try’s growth and how some mem­bers op­er­ate.

In May, the Fed­eral Trade Com­mis­sion launched an in­ves­ti­ga­tion into the mer­chant cash ad­vance in­dus­try based on po­ten­tially un­fair con­tract terms im­posed on small busi­ness bor­row­ers. The dis­trict at­tor­ney of New York has launched a crim­i­nal in­ves­ti­ga­tion into the in­dus­try while the New York State at­tor­ney gen­eral’s of­fice is in the midst of a civil probe.

Rev­enue com­mit­ted to debt re­pay­ment

Pete Tol­man, owner of Iron Born Pizza, said he was turned down by two banks at the end of 2018 when he was seek­ing cap­i­tal to ex­pand his Detroit-style pizza busi­ness to the Strip Dis­trict. Bank officials wanted three years of sales data. He had one year.

“I can imag­ine what a big bank thinks when when they see a 32-year-old kid walk in who owns a pizza shop,” Mr. Tol­man said. “All kinds of red flags should go off. As charm­ing as I am and as good as my profit and cash bal­ance looks, that’s not nec­es­sar­ily what they look for.”

He ended up bor­row­ing $150,000 from Kab­bage. He needed about $95,000 for a liquor li­cense. The rest helped him to main­tain the staff and restau­rant in Mil­l­vale and to do con­struc­tion work on the new store.

Mr. Tol­man said at the height of his bor­row­ing, his pay­ments hit about $15,000 to $20,000 min­i­mum monthly.

By con­trast, a $100,000 busi­ness loan at 5.25% amor­tized over five years would have monthly pay­ments of $1,898.60.

Mr. Tol­man said he saw the mer­chant ad­vance as a quick way to get a large in­flux of cash. But it got to a point where ev­ery dol­lar of rev­enue was com­mit­ted to prin­ci­pal and in­ter­est debt re­pay­ment.

His sit­u­a­tion changed over the sum­mer when he was able to re­fi­nance $100,000 of the debt at a lower in­ter­est rate with a lo­cal fin­tech com­pany called Hon­ey­comb Credit and get help from the city’s Ur­ban Re­de­vel­op­ment Author­ity.

Mr. Tol­man’s cur­rent loan pay­ments on $100,000 in debt with Oak­land-based Hon­ey­comb Credit are around $2,500 a month. He still owes $50,000 to Kab­bage, but he can man­age the pay­ments now that his cash flow is freed up.

Re­fi­nanc­ing debt

Hon­ey­comb Credit has been around for al­most three years, but the com­pany has changed its busi­ness model.

Ini­tially, it pro­vided loans for small busi­ness to ex­pand. Now it raises money through crowd­fund­ing to pro­vide loans for small busi­nesses to re­fi­nance high-in­ter­est debt.

“What we found are a lot of busi­nesses are tak­ing on credit card debt or short-term loans to fund their ex­pan­sion and then a cou­ple of months or years down the road they are get­ting hit with cash flow prob­lems,” said George Cook, CEO of Hon­ey­comb Credit. “We saw that sit­u­a­tion was suf­fo­cat­ing a lot of busi­nesses.”

Hon­ey­comb seems some­what like a Go­FundMe. But in­stead of everyday peo­ple do­nat­ing money to a small busi­ness, they can in­vest what­ever amount they are com­fort­able with in a lo­cally owned small busi­ness.

The in­vest­ment is struc­tured as a tra­di­tional three- to five-year fully amor­tiz­ing loan that the small busi­ness makes re­pay­ments on and those re­pay­ments are re­turned to the peo­ple who have in­vested in them. Hon­ey­comb does not guar­an­tee the loans.

“We are the mar­ket­place,” Mr. Cook said.

“What we are do­ing when a busi­ness is look­ing for a project is we do some due dili­gence. We will try to make sure there is no fraud. We try to make sure the busi­ness has a sound busi­ness plan. If the small busi­ness is suc­cess­ful in rais­ing the funds it needs, Hon­ey­comb is paid a fee be­tween 6% and 8% of what’s raised.”

The in­ter­est rate it charges small busi­nesses ranges be­tween 6% and 14%.

With the Hon­ey­comb loan, Iron Born Pizza’s in­ter­est rate came out to around 11.25%, which was a far cry from the the es­ti­mated 40% to 50% in­ter­est rate that Mr. Cook said Iron Born had been pay­ing for the money it bor­rowed from Kab­bage.

A bank­ruptcy fil­ing

Ms. Bobak hasn’t been so lucky. When she needed funds for her Porked restau­rant, she found a mer­chant cap­i­tal lender will­ing to de­posit $5,000 into her bank ac­count within 48 hours. Her cri­sis was solved for the time be­ing.

But one mer­chant cap­i­tal loan turned into an­other. Soon she was deal­ing with five dif­fer­ent mer­chant cap­i­tal lenders. She would use one loan that had a bet­ter pay­ment struc­ture to pay off an­other one.

Four of the com­pa­nies were on a monthly or weekly pay­ment sched­ule. She had to re­pay one daily. The com­pany had ac­cess to her point-of-sale sys­tem and it would pull money out of her ac­counts.

“They were with­draw­ing money from my de­posits from my credit card ma­chines,” Ms. Bobak said. “They were also at­tack­ing money from my DoorDash, PostMates and Grub­Hub [door de­liv­ery ser­vice] ac­counts. They just take it.”

The ini­tial $5,000 loan mush­roomed to around $50,000 worth of high in­ter­est debt. Ms. Bobak re­cently filed for bank­ruptcy.

The courts have stopped the mer­chant lenders from raid­ing her com­pany ac­counts and she can fo­cus on re­build­ing the fi­nan­cial health of her busi­ness.

Michael M. San­ti­ago/Post-Gazette

Natalie Bobak, owner of Porked Lin­coln Place, sits at her restau­rant in Lin­coln Place. Be­cause of high in­ter­est loans and fees, Ms. Bobak was forced to file for bank­ruptcy, which has given her some breath­ing room in get­ting her fi­nances in or­der again.

Nate Guidry/Post-Gazette

Pete Tol­man, chef and owner of Iron Born Pizza at the Small­man Gal­ley in the Strip Dis­trict, re­cently raised $100,000 to cap­i­tal­ize the ex­pan­sion of his busi­ness us­ing a crowd­fund­ing plat­form called Hon­ey­comb.

Nate Guidry/Post-Gazette

Pete Tol­man, owner of Iron Born Pizza, at his restau­rant in Mil­l­vale, found go­ing to tra­di­tional banks for loans was chal­leng­ing for a start-up like his. Natalie Bobak, owner of Porked Lin­coln Place, needed money quickly so she used mer­chant ad­vances

Michael M. San­ti­ago/Post-Gazette

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