How the world has changed! It wasn’t too long ago that an entrepreneur could go to a banker and find, at least some of, the money needed to start their venture.
However, in today’s increasingly regulated world, bankers are the last place most entrepreneurs go to find money. Certainly, friends and family are still the core of start-up money but there are new strategies for businesses which might be solutions to this age-old problem
Free markets are wonderful in terms solving problems until governments come in and screw things up. The latest funding source for small business to accommodate the un-bankable situation they’re in is called a merchant cash advance. This is a simple concept building on the age-old practice of invoice factoring. In straight invoice factoring, a company that generates an invoice for a customer typically allows up to 30 days to pay it.
A “factor” buys the invoice from the company for some discount (say 3 percent) and then provides payment immediately to the company. This is a very common practice and has gone on for as long as businesses have been generating invoices.
With the explosion in credit card usage over the past decades, financial entrepreneurs have looked for additional ways to help business gain funding. So many small and even mid-size companies don’t have access to bank credit lines or other traditional sources to fund growth.
For example, a small restaurant wants to add an oven that will double sales however it can’t get the $10,000 for the oven. Where can it go? It doesn’t generate traditional invoices that banks will use for credit line collateral or invoices that can be factored. The financial services folks came up with a solution. Why not package the forward credit card receivables into what is essentially a futures contract and discount that as a receivable thereby providing immediate cash?
For the restauranteur, if he is doing $20,000 per month in credit card receivables and wants $10,000 now, a financial company can provide the $10,000 in return for purchasing a portion of his daily credit card receivables.
Let’s assume the restaurant needs the $10,000 but can only pay it back over six months. The futures contract would purchase $11,800 of future receivables payable as $65.55 per day for 180 days. Now, the restaurateur can buy the needed oven and the funding company has earned money from buying discounted future receivables.
This is just one example of the free market versus government. The free market solution has provided the “un-bankable” restaurant with $10,000 of cash in return for purchasing $11,800 of future receivables.
To some, this is an 18 percent “interest rate” for six months use of cash. According to Big Brother in government, it’s “usurious;” that is, too high an interest rate.
But to the restaurateur, it’s a life-saver and to the investor it comes down to simply purchasing future receivables at a discount and therefore not regulated … a fair return for the time value and risk value of their money.
In a victory for the free market, the courts have upheld the legality of businesses helping fund other businesses by purchasing their forward accounts receivable at discounted rates. Merchant Cash Advances has flourished and now represents a $150 billion dollar per year behemoth.
As we move further into a digital age, this solution centered financial industry will flourish as traditional, regulated banks stymie. The next time a business asks“where do I get the capital to start or grow”, they can now look to off-bank financing as legitimate way to jump-start their enterprise.
Steve Beaman is the Chairman of The McGraw Council and the author of The Path to Prosperity.
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