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What’s filling the gap in small business lending?

Since the financial crisis, small business owners have had greater challenges getting loans. Traditional banks rarely lend those small amounts, and the community banks that typically serviced those loans have shrunk significantly.

That lending gap has been a boon for a rapidly growing financial product called a merchant cash advance. Business owners can quickly get the money they need, but it can come at a very high price.

Edgar Jones explained that many in his position don’t have other options. Jones asked to change his name for the story. He owns a company that cleans commercial sites. With less than 15 employees, the company makes about $500,000 in revenue each year. After booking a big job to do post-construction clean-up, Jones needed fast cash to buy more equipment. But the bank wouldn’t approve the small loan he was looking for. So he turned to a merchant cash advance, or MCA.

“At that time, you be so vulnerable you take it because you really need the money at that time. After that, that’s when things either go uphill or downhill,” Jones said.

The MCA company deposited the money in Jones’ account and began collecting on that debt the next day.

“When the checks don’t come on time, then they hit your account and then your account is in the negative,” Jones said.

So when the repayment period was up, Jones said his bank account was still being drained. In order to pay off his most recent advance, he had to take on side jobs.

Jones’ credit score wasn’t much of a factor in getting approval for the merchant cash advance. What mattered most was his daily cash flow.

Here’s how it works. The MCA firm will deposit a lump sum into the business’ account, and then repayment can happen one of two ways. The MCA firm could collect by taking a cut of the business’ daily credit card sales. If there’s no credit card sale that day, there’s no collection.

With the other repayment plan, the MCA firm takes a daily withdrawal from the business’ account. If there’s no sale that day, the MCA firm still debit the account. The repayment period is usually a short amount of time, like 90 days.

Sean Murray with the Daily Funder, a merchant cash advance forum, said it’s the business owners’ responsibility to comb over the fine print. He hasn’t heard of bad actors in the industry, but said he’d be disappointed if the contract wasn’t fully explained.

“At the end of the day, if they don’t get back their money. It hurts them, too,” Murray said.

Merchant cash advances first came on the scene in the late 90s, but really took off after the financial crisis. Murray expects this industry to be worth about $5 billion for 2014. That’s small compared to the personal lending industry, but it’s big growth from the millions MCAs earned before the financial crisis.

Murray said the interest rate on an APR basis does seem high, upwards of 80 percent.

“But what’s important to note when we’re talking about costs that are high like that—these loans sound really, really high–is that these loans advertise daily. And so the actual cost of the money might only be 20 percent. Let’s say I give you $10,000 and the cost is $2,000, so that’s 20 percent,” Murray explained.

The MCA might be referred to as a loan, but it isn’t the traditional personal loan with which most are familiar. It escapes the scrutiny of regulation.

“Merchant cash advances are business-to-business transactions. They don’t involve consumers. The consumer protections that exist elsewhere in the market don’t really apply to businesses. It doesn’t mean there are no laws, and it’s a free for all. But the laws are generally pretty lax,” Murray said.

There’s not really a central office these companies report to. It’s not something that state lawmakers are keeping an eye on either.

Murray said people can certainly file any complaints with the Federal Trade Commission. He said the general industry consensus is that self-policing is the best option.

“Regulators come in and have a tendency to see part of the picture. It makes things more difficult for everyone else in the long run. It ends up hurting the customers they’re trying to protect rather than helping them,” Murray said.

Kevin Daleiden is the owner of Flange Advantage in Waukegan. He and two other men sell nuts and bolts out of a warehouse. Daleiden’s taken out at least seven merchant cash advances. He said he’s planned carefully for each one, but has still been caught off guard by fees he didn’t notice in the contract terms.

“One of the hardest things to get out of people at the very front is give me the payoff information. Give me the way I pay this back to you. There’s not a one of them out there that will tell you the facts upfront. And they won’t put it in writing until you’re signing the documents,” Daleiden said.

He said he’s constantly getting calls, emails and letters from MCA firms trying to get him to sign a deal.

“I don’t know how they get my name, but there’s hundreds of these companies out there and I think they call me everyday. I’ve had one gentleman that yelled at me, says ‘you need to give me all your business.’ I said ‘I’ll give my business to who I feel comfortable with,’ and he actually yelled at me on the phone,” he said.

Daleiden is trying to move away from MCAs and toward microloans. He’s now working with the Chicago non-profit Accion for his latest deal.

Microloans are what they sound like, smaller loans to small businesses distributed by a qualified non-profit. Accion services amounts $100,000 and less.

CEO Jonathan Brereton said it’s a better loan option with less than 5 percent defaulting, but MCA firms can distribute the money faster. Brereton admits meeting the demand is a big challenge.

“We think the market has a need and supply, there’s still an enormous gap. So we think we’re only serving about 15 percent of the market demand in Chicago,” he said.

Brereton said this past year has exploded with clients like Edgar Jones and Kevin Daleiden trying to get out from under merchant cash advances. He’s even seen people layering them.

“So they take one, cash flow gets tight. They take another. We’ve seen people take five or six loans from different lenders. All in the 100-190 percent interest range. But no where on any of the agreements does it specify the actual interest rate,” Brereton said.

The gap in small business lending left behind by the financial crisis allowed merchant cash advances to thrive. The product has helped some businesses increase their revenue when they otherwise wouldn’t have.

But Kevin Daleiden said it’s also the reason why some businesses have failed.

“My merchant advances have made them more money than I’ve taken home this year, and I’m doing the work. But I did that knowing it would be expensive. I had a goal,” Daleiden said. “If you don’t’ have a long term goal, a way in and a way out, the merchant advances will kill you.”

Susie An is the business reporter for WBEZ. Follow her @soosieon.

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What’s filling the gap in small business lending?

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