Nearly 60 million Americans — and 7 million Californians — work at a small business. That’s roughly half the private-sector workforce. Yet for all the value these companies add to our economy, they still struggle to secure short-term capital when they need it.
Banks are usually a long shot. In July, America’s large banks denied three in four small business loan applications. Community banks were just a touch more generous.
It’s no wonder, then, that a growing number of small businesses are turning to alternative forms of finance. One option, “merchant capital” — an arrangement in which a company provides quick cash to a small business in return for a percentage of its future sales — has proven particularly popular in recent years
But lawmakers across the country, including here in the Golden State, are targeting this form of finance, claiming that it’s too costly. If lawmakers succeed in these efforts, life will get a lot more difficult for small businesses — and the millions of Americans they employ.
Small businesses need quick infusions of cash for all sorts of reasons. Consider the neighborhood ice-cream shop that loses its freezer in the middle of the summer — or that clothing store that needs to act fast on a promising new retail location. Or think about the small software company that needs to make payroll, but is still waiting on checks from a half dozen dependable — but notoriously delinquent — clients.
Merchant Capital: Quick Cash
In all of these scenarios, access to quick cash doesn’t just help the business — it helps employees and the overall economy.
Situations like these are fairly common. One in five small businesses either dipped into personal funds or relied on external financing last year in order to cover operating costs, according to a Federal Reserve survey.
This is especially true in California where the cost of operating a business are exorbitant. In fact, California ranks 49th out of 50 for the most expensive states to do business, according to one study.
The thicket of regulations foisted on California business owners often puts them in the unfortunate situation of having to reach out, quickly, for capital. I should know — for six years in a row, Sacramento has delivered higher-than-expected tax bills to all employers in the state because of a debt it owes to the Federal Unemployment Trust Account. Since the state isn’t supposed to be in debt, businesses don’t expect these tax bills.
For many small firms, turning to merchant capital — also known as a “merchant cash advance” — is a much safer bet than trying their luck at a bank.
With this form of finance, small businesses receive cash in exchange for a fixed percentage of their future sales until they’ve paid everything, plus a fee, back to the merchant capital provider. Retailers typically deduct a percentage of their credit and debit card transactions automatically to cut down on administrative hassle.
Traditional Loan Failure
There are plenty of reasons why a business might prefer this approach to a traditional bank loan.
For starters, banks are pretty stingy with small business loans. Merchant capital providers are less easily scared away by small businesses — and don’t put as weight on business owners’ personal credit histories.
Sometimes it’s just an issue of time. Businesses applying for a merchant cash advance get an answer in a matter of days, and sometimes hours — not weeks or months, as with a bank loan. This is crucial for firms in a crunch that don’t have time to navigate a complicated loan application process.
On top of that, bank loans are usually repaid through fixed monthly payments — regardless of how well a company is performing. Payments for merchant cash advances are based on a business’ actual sales. This means the capital provider only gets paid when the business makes money.
In short, merchant capital gives small companies another option for dealing with unexpected expenses. And sometimes, this financial tool is the only way to keep a business’ doors open or avoid a large-scale layoff.
Nevertheless, California lawmakers are trying to undermine the merchant capital industry. Both the state Assembly and Senate recently passed S.B. 1235, a bill that would require all alternative finance companies, including merchant capital providers, to use a new, uniform metric in disclosing financing costs associated with their products.
California Governor Jerry Brown just signed the bill into law.
Cali’s Meddlesome ‘Metric’
The newly-created metric, dubbed the “Annualized Cost of Capital,” is more likely to disorient customers than to illuminate the real nature of alternative finance products.
And the likely result of all of this confusion will be an increase in the legal and administrative costs borne by the industry — a consequence that will surely make merchant cash advances few and far between in California.
The same is true for New York’s effort to regulate merchant capital through the state’s Department of Financial Services. By forcing the industry to comply with a thicket of regulations and requirements, the reform would burden the industry with new administrative costs and complications, thereby hindering its availability to New York businesses.
Merchant cash advances provide the short-term capital that small firms need to survive and thrive. California leaders who want to promote a vibrant, growing economy need to see the merchant capital industry as an opportunity — not an unwelcome threat to business owners.
- Myers is an Orange County small business owner with over two decades of experience at America’s leading technology firms. He is also an adjunct lecturer at Biola University and serves as program chairperson for the Lincoln Club of Orange County, a pro-business PAC.