Why most small business owners default on alternative loans and advances and what to do it you do.

There are over 32 million businesses registered in the United States. However, few small business owners have access to affordable and reliable small business funding. As a result, small business owners often seek alternative funding sources to meet their needs, and small business funders are eager to provide the necessary funds.

Nevertheless, both the SEC and our firm estimate that default rates on alternative loans and merchant cash advances can reach or exceed 50%. In this article, we examine several (possibly harsh) reasons why so many small business owners default on their funding.

By Thomas Tramaglini, Chief Operations Officer

The Center for MCA Research

thomas@beaconclientsolutions.com 

About Thomas Tramaglini

Initially, the concept is straightforward. A business requires funding, and the only option is a merchant cash advance (MCA). A small business owner applies and receives the funds within a day or two.

Then, the challenges begin.

Most small business owners who opt for MCAs face daily repayments, high interest rates, and short repayment periods. These factors make it difficult to fulfill their obligations. Consequently, the owner might seek additional funding or default on their commitments. Many find no clear way out, encountering legal actions, UCC filings, harassment, damage to their business reputation, and more.

Does this sound familiar?

The team at Beacon witnesses this daily. Small business owners quickly find themselves in deep trouble.

Addressing the adverse effects of predatory lending in small businesses can be tough, as the harm is often already done. This article examines the reasons small business owners default and the consequences they face.

The science behind alternative lending with merchant cash advances is deeply flawed.

Perhaps the primary reason small business owners default is that the funder should never have provided the funding in the first place.

How does the funding process work?

Small business owners submit their bank statements to alternative lenders. Typically, three months of statements and an application are required. So-called underwriters (who aren't truly underwriters) assess factors such as the number of deposits a business owner makes, daily balances, expenditures, negative days, and any other criteria they deem important for funding.

It's evident that those funding these deals are merely taking calculated risks to fund the business owner and ensure quick repayment.

Banks have a very low default rate. Why? They rely on data accumulated over time, based on the profits a small business reports on taxes and financial statements. Among other metrics, banks use the Debt Service Coverage Ratio (DSCR), which is derived from a business's long-term profitability. Typically, banks approve loans that meet a 15% profit margin.

While banks make borrowing difficult, they maintain a low default rate and relatively low risk. Conversely, using three months of bank statement data is a poor method for predicting repayment ability. Bank statements provide minimal insight into a business's ability to repay or potential financial challenges, as they don't include debt payments, contractual commitments, or factors influencing financial trends (such as economic conditions, interest rates, etc.).

Many MCA companies and small business funders have no idea what they are doing.

There is no certification or license required to operate an MCA company. Often, MCA companies consist of just a few individuals who have combined their own funds with those of investors to distribute money. Many MCA companies lack the knowledge of how to assess financials, taxes, profit and loss, debt schedules, and more.

This is clearly demonstrated when MCA companies choose to provide 5, 6, 7, or more advances to individuals. In such situations, it seems more like gambling with small business owners' futures so that MCA companies can quickly amass wealth. Some small business owners become so over-leveraged that they struggle to pay personal bills and cannot possibly repay a cash advance. Yet, they still receive funding.

We aren't suggesting that money lenders need a Harvard education, but many in the industry are uneducated, poorly trained, and lack the fundamental knowledge to manage fiduciaries that support small businesses. The products these funders offer often lead to suffering for both individuals and businesses in numerous ways.

In our view, this constitutes financial malpractice.

Many small business owners have no idea what they are getting into. 

Just as many funders are unsure of their actions, numerous small business owners are unaware of what they are agreeing to. Therefore, when a small business owner agrees to a cash advance with a payback fee exceeding 50% over 120 days, along with daily payments and hefty origination fees, the results can be disastrous. Small business owners should thoroughly comprehend the commitment they are making, the potential consequences of failure, and how it might affect their business. With 1 in 2 small business owners failing, it's clear that many do not realize what will happen to them until it's too late.

Small business owners are unclear of what alternative loans and merchant cash advances are and how they work.

Merchant cash advances are not loans; they are purchases of future receivables that alternative lenders use to quickly generate profits. However, many small business owners mistakenly believe these arrangements include safeguards, such as the option to consolidate debt in the future, which is seldom true. Small business owners often anticipate receiving support if they encounter difficulties in meeting their repayment obligations. While some funders take a proactive approach and collaborate with small business owners, the majority do not, and once a default happens, significant problems arise.

Dishonesty rules the alternative lending world and small businesses pay the price.

In the absence of regulation, there are minimal protections for small businesses against prevalent dishonesty. Our firm encounters issues daily, such as counterfeit bank statements, fraudulent contracts, misleading claims about funding, false promises of consolidation, and more. There is NO accountability for those who exploit and harm small business owners. This lack of honesty allows alternative lenders and brokers to take advantage of business owners until their financial resources are exhausted.

Brokers

Without a doubt, brokers are among the most predatory figures exploiting small business owners. While there are some trustworthy brokers, the majority are not honest and show little regard for either the advance companies or the business owners. They engage in practices such as adding unauthorized fees, failing to disclose important funding details, lying, cheating, altering bank statements, selling your information, plagiarizing, harassing, and more.

Clearly, brokers are a significant reason why small business owners struggle to repay their advances and face hardships.

Alternative Lenders

Just as with brokers, while there are some exceptional alternative lenders, many are terrible. They often exploit small business owners, take advantage of their vulnerabilities, and when these owners face difficulties, the lenders step in and do whatever they can to ruin them. In general, they have the capacity to offer terms that are manageable and could reduce default rates. However, they choose not to. They avoid doing so because their sole focus is on making money quickly.

For our firm, even though it's possible to support small business owners and earn profits, few predatory lenders are interested in making this industry trustworthy, supportive, or ethical.

It is get rich fast world and that is pretty much it.

So What?

The team at Beacon Client Solutions regularly works with clients who have been taken advantage of by MCA companies.  Specifically, those business owners who have been burned.

The solution is simple.  Get Help.  Now.

Dr. Thomas Tramaglini is the Director of Operations and Negotiation for Beacon Client Solutions, a company that supports small businesses on a host of fronts, especially MCA debt. Thomas has been a small business owner for many years, as well as held leadership positions in several organizations and companies. Thomas holds a B.A. in History, as well as Masters and Doctorates in Organizational Leadership from Rutgers University, The State University of New Jersey.

Disclaimer: Beacon Client Solutions is not an accountancy, or a law firm. We are business consultants. While Beacon works with outstanding attorneys and accountants, we cannot and do not provide legal or tax advice. All of our work is connected to those who are legally certified to give such advice. Beacon does have a longstanding body of work in MCA resolution and understands what small business owners deal with, specific to MCA. Beacon Client Solutions serves clients in all 50 states, Puerto Rico, Mexico, and Canada.