SBA Loan Vs. Merchant Cash Advance
August 23, 2011By: Sean Murray
“I’ll pass on the Merchant Cash Advance and get a SBA loan from my bank but thanks anyway.” It’s a response many representatives in the Merchant Cash Advance (MCA) industry hear often. Some of those business owners return within just a few months and request to pick up where they left off. It would be a safe assumption that they were declined for a loan and forced to go this route as a result, but surprisingly that is rarely the case… The Small Business Administration (SBA) has been guaranteeing loans for banks since 1953. Given their long history and government affiliation, business owners widely consider them to be performing a public service. Welfare, food stamps, and fair business loans for all! Despite the appeal on the surface, the SBA is not your friend. Data shows the SBA has teamed up with banks to form the most dysfunctional lending force in operation today. According to the Coleman Report, more than 1 out of every 10 recipients of a SBA loan defaults, an eventuality that leads to the repossession of your business, your business assets, your home, your furniture, your equipment, and even your car. The only thing an SBA loan has in common with welfare is that you are very likely to need welfare after the bank auctions off all your property. The SBA is not a lender. They merely guarantee an enormous percentage of business loans that banks underwrite and approve. And we all know how banks feel about us… (Banks break in to homes facing foreclosure, Banks wrongly evicted millions, Federal Reserve Cracks Down on Bank Overdraft Fees, America’s Major Banks Commit Fraud, Arizona sues Bank of America for fraud, etc..) Before this article starts to look like a one sided slugfest, let’s examine the major reason business owners are drawn to bank loans, the interest rate. “I’d rather get a fair interest rate with the SBA than use a Merchant Cash Advance. A MCA is too expensive.” It’s a reasonable argument and usually the one MCA representatives dodge or cower in fear when they hear. The MCA industry has low self esteem when it comes to challeging banks and it’s warranted. The SBA is currently backing over $80 Billion on active loans. In 2010, the Merchant Cash Advance industry provided approximately $500 Million to small businesses. By comparison, this is a ratio of 160 to 1. Banks tend to be a business owner’s first choice of capital because they are told it’s the smartest way to go. It’s conventional wisdom and nobody likes to challenge conventional wisdom. It’s very similiar to the assumption that investors could expect to earn 7-10% on their money every year in the stock market. We laugh at that premise now but that’s printed as a fundamental truth in every finance textbook published prior to 2008. So bank loans are less costly… or are they? The maximum allowable interest rate on a 7(a) SBA loan for a term under 7 years is Prime + 2.25%. The current prime rate is 3.25%, so that brings the maximum cost to 5.5% APR. 5.5% is great but before you throw your Merchant Cash Advance application in the trash, let’s discuss the closing fees: Other possible restrictions that are likely to impact the overall cost: And we really can’t forget: Once fees are considered, the low APR loan is nearly in the same ballpark as a MCA on an overall cost basis. If cost is supposed to be the dominant argument against MCAs, then brace yourself for the rest of this debate between the two financial products. Doing More Harm Than Good A Merchant Cash Advance is repaid only at the pace that the business is able to generate revenue. A percentage of each credit/debit card sale is withheld up until the total amount of purchased receivables are recovered. Therefore, businesses will contribute less to the MCA provider in months where sales are down and more in months where sales are up. By contrast, banks require a fixed payment regardless of sales volume or seasonality. Obtaining a SBA loan through a bank is a lengthy process, and a great burden is placed on the borrower to prove they are worthy and able to repay. MCA’s require very little documentation and have an average turn-around time of 7 days. Given the bank’s methodology and seemingly lower rate, business owners create this perception that banks provide a more sustainable source of funds. The SBA does not make these statistics public but what does the data show? MCA’s also accept higher risk business and with far less documentation, making the lower rate of default all the more impressive. Opponents of MCAs attempt to brand providers of this product as aggressive. Yet research shows that banks are more likely to bring a business down and infinitely more likely to rob you in your sleep and sell off your collateral. Do SBA loans really take longer to obtain? There seem to be a milliion articles online touting that a MCA is much faster and easier to obtain than a bank loan. We would like nothing more than to assume that’s true, so we took a look for ourselves. Documents required by average Merchant Cash Advance provider: (As detailed here) Documents required for SBA lender: (As detailed at business.gov) The difference is substantial and yet this comparison fails to mention that the added paperwork of a SBA loan doesn’t bless the business owner with the fortune of a higher approval rate. In fact it is just the opposite. Isn’t it true that Merchant Cash Advance providers have huge profits? A Merchant Cash Advance can seem expensive at first glance but that’s because bank loans hide the overall cost in their list of hidden fees, thereby erasing the benefit of a low APR. Business owners argue that banks already manage to make a fair profit with traditional lending so why does it seem like MCAs are charging so much more? The rebuttal is that banks are not actually managing a fair profit. Surprise! In fact, business loans are so unattractive to banks, that they would prefer not to do them. The whole point of the SBA is to incentivize banks to lend to small businesses. Defaults are so high and profits are so low, that a government guarantee of up to 90% of the balance is still not incentivizing enough for a bank to do this. A quote from an article in the NY Times, “Just because the S.B.A. may be willing to guarantee the loan, the bank may not necessarily want to make the loan.” When borrowers default, the bank incurs the cost of collecting it, processing it, acquiring the collateral, and liquidating the collateral. Do the math: if 5.5% APR plus a parade of fees and a guarantee that up to 90% of any losses will be reimbursed is not incentive enough to lend, then we’ve got a major problem. Take away the default guarantee safety net and it is likely that traditional banks may begin to consider a business loan at Prime + 40%. The SBA default guarantee singlehandedly distorts what a reasonable return on investment should be on a business loan. You can’t blame a business owner for believing 5.5% to be a fair rate when that is what the public is led to believe is profitable for banks. If Merchant Cash Advance providers were so profitable, then everybody would be in the business. A handful of MCA providers in 2008 went under and not because the rate of default was too high. A 35% return on investment per business simply could not cover the cost of overhead like rent, salaries, paper, supplies, computers, equipment, legal fees, marketing, electric, water, taxes, healthcare, etc. In the end, executives and shareholders came to the realization that providing capital to small businesses was a tougher task than once thought. “You start to realize why big banks charge overdraft fees, minimum balance fees, and checking fees. It’s because they’re not making money by lending to anyone,” stated the former vice president of one defunct firm. The SBA wouldn’t exist if it was really that bad This couldn’t be more wrong. Politicians and top ranking SBA officials alike have lobbied for years to abolish what they believe to be an ineffective, wasteful system. It’s a burden on the taxpayer, banks don’t like to do it, and businesses rarely benefit from it. CNN actually refers to the SBA as a quagmire. Pass on the loan “I’ll pass on the loan and go for a Merchant Cash Advance but thanks anyway” is a phrase likely to gain steam over the next several years. It’s a response that loan officers might get caught off guard with. It will be a long road until this relatively young financial product is widely accepted but evidence suggests that it’s gaining traction. Until then, throw conventional wisdom out the window. The stock market doesn’t produce 10% returns every year and your bank isn’t the best source of capital…. -The Merchant Cash Advance Resource http://www.merchantprocessingresource.com/merchantcashadvanceresource.htm The author of this article has a B.S. in Accounting & Finance and has a played a central role in providing over $100 Million to small businesses. ======================== Everything business owners need to know about Merchant Cash Advance
Sean is the founder of Merchant Processing Resource, the co-founder of the Merchant Cash Advance forum, DailyFunder.com, the developer of the first Merchant Cash Advance industry iPhone app, and a moderator of both the Small Business and Entrepreneur communities on Google+. Learn more about his Merchant Cash Advance background on LinkedIn or follow him on Google+.
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