Alternative Financing Landscape
The alternative financing market is more than doubling in size each year. Whether you or your business has good or bad credit, or you are seeking funds for a start-up or charitable cause, billions of dollars are being donated, lent to or invested in entities each month. In the three sections below, we provide detailed explanations of the different alternative financing products, industry trends and statistics, and 9 warnings for borrowers.
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Alternative Finance Explained
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Alternative financing comes in many forms from many sources all over the world. Ask 10 professionals how to define “alternative financing” and you will get 10 different answers.
For our 2015 Alternative Financing Directory, we included over 700 organizations that:
- Use technology to enable extremely fast authorization and financing;
- Use technology to connect crowdfunding and peer to peer finance sources;
- Offer non-traditional forms of financing.
Traditional forms of financing, such as bank loans, charitable grants, venture capital, payday loans, credit cards, home equity loans, private placements, friends and family loans, equipment leasing, and SBA loans were not included in our directory.
There are two main drivers in the explosion of alternative finance availability: technology and the Great Recession. FinTech (financial technology) uses software to enable financiers to easily collect information over the internet, analyze and determine lending criteria within minutes, create new forms of lending and repayment, and connect individual consumers and investors to those in need of money. The Great Recession of 2008 caused governments to lower interest rates to near 0%, making investors look for higher rates of return in alternative investments to savings accounts and corporate bonds. Over 90% of the 700+ organizations in our survey were founded since the Great Recession. The monetary value of alternative finance investments is doubling in size each year.
Alternative Financing Directory
Our collection agency started receiving claims in 2013 from alternative finance providers offering money in ways not seen before. Many borrowers were very thankful for the loan and we just needed to re-work repayment terms. We realized this financing could help other companies and started building a list of resources.
We soon discovered a huge industry with no central place for companies, consumers, and charitable supporters to find financing resources. That’s when we decided to create a filterable search tool of over 700 organizations to help those who need financing.
Introducing the Alternative Financing Landscape
Alternative financing is available to businesses, individual consumers, non-profit organizations, and even single charitable causes such as funding someone’s unexpected medical costs, regardless of credit history. Money is available as equity (e.g. ownership in a company), debt (e.g. to be repaid), exchange or reward (e.g. the financier gets a product instead of equity or repayment) or simply donated. Often, the cost of the money (e.g. the interest rate or equity price) is similar to or even less than the cost from traditional financing sources. However, for those with bad credit history, the cost often is very high and borrowers need to be cautious.
During our survey, we identified 8 different types of alternative debt financing. While some may not be called loans, they do require that a fixed amount of money be repaid to the financing source. The implied interest rate could be as low as 4% or as high as 100% or more. Some debt types are relatively new forms and others are traditional except for the FinTech approach for quick decisions and funding or access to new financing sources. The 8 debt types are described below.
Merchant Cash Advance
Also known as MCA, technically, this is not a loan and not subject to the same federal and state regulations of lenders. Instead, the financier purchases a portion of a company’s future credit card sales and gets repaid by taking a fixed percentage of daily credit card transactions until a certain amount has been repaid. For example, the financier may purchase $28,000 of future credit card sales for $20,000 and get repaid at the rate of 15% of daily credit card sales. The seller/borrower gets $20,000, and then every day it automatically pays back 15% of whatever the business generated from credit card transactions. If daily credit card sales are $1,000, then 15% or $150 is repaid to the financier. This continues until the $28,000 has been repaid, which would take 186 days if the average repayment was $150 per day.
A merchant cash advance has several advantages and disadvantages. Companies can often get approved within minutes and funded within days, including those with poor credit history. The fixed rate of repayment can be very affordable. It is typically 10% to 15% of daily credit card receipts, but we have seen it as high as 31%. If your company’s credit card sales slow down from $1,000 a day to $500 a day, the repayment also goes down, from $150 a day down to $75 a day in our example above. This can be extremely important for businesses subject to seasonality or bad luck (like unexpected street construction deterring walk-in traffic). However, not all MCA providers adjust the daily withdrawal amount automatically. Some only adjust monthly on a reconciliation basis which can put extra stress on a business experiencing declining revenues.
The money is taken automatically from the bank account that credit card receipts are deposited into, so the seller/borrower doesn’t need to worry about making payments. However, the implied interest rate can be high. In this example, there is $8,000 in implied interest, which represents 55% of the $20,000 amount received. You can use our implied interest rate calculator below to compare offers from multiple vendors.
Revenue Cash Advance
This is similar to a merchant cash advance, but for businesses that don’t have much in the way of credit card sales. For companies that get paid by check for invoices, the financier purchases future receivables at a discount and then gets paid back a fixed amount each business day. The financier may buy $42,000 of future receivables for $30,000 and then get paid back $200 every business day. The $200 is taken out of the company’s bank account automatically via ACH each day.
The advantages of a Revenue Cash Advance include an affordable small daily repayment, quick and easy approval, and availability to companies that do not qualify for traditional bank loans. However, unlike an MCA, the amount paid back daily is fixed instead of based on daily sales. The implied interest rate, which is 50% in this example, also can be high.
Business Cash Advance
Some financial sources call their Merchant Cash Advance a Business Cash Advance (BCA). Other financial sources call their Revenue Cash Advance a BCA. To avoid possible confusion in our list of alternative financing sources, we do not use the BCA term, and instead use either MCA or Revenue Cash Advance.
Receivables Based Financing
This differs from a Revenue Cash Advance or Business Cash Advance as the lender looks at the borrower’s actual accounts receivable balance and historical invoice collection history to determine credit worthiness. Loans can be based on total accounts receivable balance or financing of individual invoices. For example, one popular provider connects to your internal accounting system and allows the business to borrow against a specific invoice and repay with 12 equal weekly payments. Once a business gets approved, the business can decide to borrow against invoices whenever they need to and get funded immediately. The interest rate on these loans can be much lower than on an MCA or RCA.
Accounts Receivable Factoring
Factoring has been around for decades, but with FinTech it now gives businesses more flexibility in choosing when and how much to borrow. With factoring, a business sells an uncollected invoice owed by one of their customers to the Factor for a discount (often 5%). So, if your company is owed $10,000 by a customer, the Factor pays you $9,500 and then in turn the Factor collects the $10,000 invoice directly from your customer, making a $500 profit. Traditionally, the invoices were sold “with recourse”, which means that if the Factor did not collect directly from the customer, they would go back to the Seller to get their money returned. Many factors now purchase invoices “without recourse” which means that even if they don’t get paid by your customer they cannot go back to the company that sold/factored the invoice to get their money back. The implied interest rate is typically much higher than traditional forms of finance.
Inventory Financing or Working Capital Loan
While many financiers say they provide “working capital loans”, in reality they are providing other types of loans (merchant cash advance, factoring, etc) so the borrower can use the loan proceeds for working capital. A true working capital loan uses a company’s existing working capital (inventory and receivables) as collateral and the amount lent is based on these values and planned inventory purchases. This type of loan can be good for companies that have to carry a lot of inventory or need to purchase additional inventory due to increases in orders. Traditional banks are the primary source for inventory loans, but we did find 6 alternative finance lenders who base loans on existing inventory and planned future purposes. Supply Chain or Purchase Order Financing is another option for companies that need assistance in this area.
Purchase Order or Supply Chain Financing
Purchase Order Financing allows you to borrow money when you get a purchase order so you have the money to buy raw materials inventory and turn that into the product to be sold. Supply Chain Financing allows companies selling products to get paid sooner, but allows their customers to pay upon standard or longer terms. It is most commonly used in cross-border transactions. It works well when the buyer is a large company with excellent credit and their vendor, the seller, does not have access to traditional low-cost bank loans to provide working capital while waiting to be paid on outstanding invoices. It is often called “reverse factoring” because the buyer gets extended payment terms to pay invoices owed to suppliers while suppliers get paid faster without the typical large discount a factor requires.
Asset-Based Financing including Equipment Leasing
Asset-based loans and lines of credit require a specific asset as collateral for the money borrowed. This could be accounts receivable, inventory, capital equipment, and/or other assets and the amount you are allowed to borrow is tied to the value of these assets. Banks and other lenders have been providing this type of financing for centuries. Our survey found a number of alternative finance companies that specialize in loans based on capital equipment or total assets, including some specializing in providing funds for new equipment on a lease program. Others specialize in consumer loans backed by the person’s luxury assets (jewelry, art, boats, etc.) or retirement plans (401K, IRA). These financiers use FinTech to make much quicker decisions and disbursements and have different credit criteria than banks.
Loans, Lines of Credit, and Micro-loans
Loans will have a fixed term and repayment schedule with a specific interest rate. The interest rate may be fixed or vary with changes in market interest rates or may be 0% when trying to help entrepreneurs in developing countries. The borrower gets all proceeds on the day the loan is funded. If pre-payment is allowed, the borrower can lower their cost by paying off the loan sooner. With a Line of Credit, the borrower can borrow when they need money, pay it back, and borrow again, as needed, during the term of the line of credit. Interest is paid only on the amount actually borrowed and outstanding. These are traditional banking finance products, but alternative financing providers use FinTech to make decisions faster and use different criteria than banks to determine how much to lend. The alternative finance providers also often turn to crowdfunding, peer to peer lenders, individual investors, and alternative institutional players to raise money to then lend to borrowers, whereas banks typically depend on depositors and traditional methods of raising capital to lend out. A loan or line of credit will probably be less expensive than a merchant or revenue cash advance or invoice factoring, so if your business qualifies this may be the preferred alternative financing vehicle.
Micro-loans are simply much smaller loans than banks have ever made. They first started appearing in emerging markets and typically were under $1,000. Now businesses in emerging markets are getting micro-loans up to $10,000. Several alternative financing organizations are now also providing micro-loans in developed markets such as the USA and Western Europe.
Equity means ownership in the company seeking financing. This is typical for start-ups rather than small and medium size businesses. Investors are hoping the early-stage company will grow to be very large and either sell itself to another company or go public. The investor does not get paid back their investment and instead earns money from the company’s profits and increase in value.
As an alternative to borrowing money to be repaid back, selling equity shares in a company, or seeking donations, businesses, non-profit organizations, and charitable causes may instead offer something else to the person providing the money. Some early-stage companies offer the product they are creating to people who provide the funding so the product can be manufactured. For the business, they get the money they need without having to give up equity shares or pay it back and they also get their first customers. Non-profit organizations and charitable causes may give a physical product, such as a t-shirt or other merchandise, in exchange for a donation. There are now many websites which make it easy for non-profits and charitable causes to offer a custom designed product to potential donors as a way to assist with fundraising. This is called “reward financing” since the person gets a reward instead of their money back or an equity stake.
Non-profits and charitable causes typically just seek donations. Our Alternative Financing Directory has over 200 websites that help with publicity and make it easy for people to donate to a specific charitable cause. Many of these are set up for specific situations such as to help a family with medical bills or loss of their residence due to fire or other disasters. Often money raising campaigns for charitable causes are set up immediately after an unfortunate event and contributions are not tax deductible as there is no official non-profit organization.
Non-profit organizations can also use these websites for campaigns and contributions are tax deductible.
Some of the sites are geared toward individuals seeking funding so they can accomplish a personal goal, such as travel to a foreign country to provide charitable services or research a specific issue.
Financing Sources for Alternative Financing Providers
In addition to determining the type of financing you are seeking, you may also want to consider where the money comes from as this may impact the likelihood of getting funding and/or the cost.
With Crowdfunding or Crowdsourcing, small amounts of money are raised from a large number of people. This is made possible via the internet and crowdfunding websites.
Start-ups and early stage companies may find it easier to get crowdfunding than to raise venture capital or find angel investors. In these situations, the start-up may need to find a reputable or famous person to announce they will back the venture to get others to join in.
Small businesses that would never be funded by venture capitalists due to limited growth prospects can also find success with crowdfunding. In this case, individual investors can be seeking higher returns on their invested capital than they can get from savings accounts at banks or investing in the stock market. Small businesses and early stage companies may find it is easier to get money from crowdfunding instead of alternative financing sources that get their lending or investing capital from institutional investors who may have more strict funding criteria.
Non-profit organizations and charitable causes typically rely on crowd-funding for donations. With the internet and FinTech, this has become much easier.
Peer to Peer
Peer to Peer Lending (P2PL) is similar to crowdfunding in that the borrower offers the financial opportunity to the world via the internet. The difference is that in P2PL, potential individual lenders bid against each other by indicating what interest rate and repayment terms they find acceptable. The borrower can then pick from whoever gives the lowest interest rate or slowest repayment terms.
The websites that facilitate P2PL typically take fees that are much lower than what an alternative finance company charges to fund a loan from money raised from their institutional investors. So while your business might get approved for a merchant cash advance in 10 minutes and get funded within days, that funding may be much more expensive than a Peer to Peer loan. However, it can take much longer on a P2PL website to find one or more people ready to fund your requested loan. Some P2PL websites do not have bidding. They simply create a marketplace for lenders to find borrowers.
The majority of alternative finance companies in our survey are direct lenders. They raise money from institutional and accredited investors and then in turn lend that money to the businesses and consumers seeking loans. They promise their investors either a specific return on investment or a share of the profits. Knowing that they have money immediately available to lend and what it cost for that money, they can make immediate decisions when borrowers apply and fund loans as soon as paperwork is complete. In exchange for the speed of the approval and funding process, this can be more expensive than going direct to small investors via crowdfunding and peer to peer markets.
Brokers typically line up several different funding sources so they can offer several different types of loans. One advantage of going to a broker is that they may be able to offer the business or consumer several different types of loans and the borrower can then pick the one that best fits their needs or the lowest cost. This may also help the borrower understand what types of alternative financing they qualify for and the cost. Brokers typically have competitive prices but the borrower can always go to websites of direct lenders offering the same type of loan to compare prices.
Opportunities for Investors
While our survey and searchable database is oriented towards helping people find ways to raise money, they can also be used by investors who are looking for ways to invest or donate. Investors can choose their specific investment when using crowdfunding and peer to peer lending platforms. Or, many direct lenders seek financing from accredited investors. These direct lenders often allow investors to determine the risk level for their investments, offering higher returns for greater risk.
Alternative Finance and Digital Investment Trends
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The aftermath of the Great Recession of 2007-2008 combined with the rapid transformation for doing business via the Internet has resulted in the creation of a new and fast growing alternative finance market. The amount of capital accessed via alternative finance is more than doubling each year, from $6 billion in 2013 to $16 billion in 2014 and an estimated $34 billion in 2015. The growth opportunity is enormous as the addressable market exceeds $3 trillion.
The liquidity issues in 2007 and 2008 caused the worldwide economy to suffer dramatically. Governments dropped their interest rates to nearly 0% to prime the economy and seven years later rates remain at or near these historic lows. While banks and large corporations have enjoyed having this low cost funding sources, banks also cut back significantly on the risk they were willing to take with loans. This just made it even more difficult than typical for small and medium size businesses to get capital. As recently as October 2014, the Federal Reserve’s Senior Loan Officer Opinion Survey on Bank Lending Practices indicated that “underwriting policies for approving applications for retail small business loans were somewhat tighter than the midpoint of their range over the past decade.”
At the same time, the low interest rates meant investors were getting much lower interest on their capital so they started looking for alternative investments with higher rates of return. As high speed internet service, mobile phone access, and general comfort doing business on the internet became the norm, it opened the doors for new ways of raising and investing capital. Companies created technology to make crowdfunding easy and it became popular for charitable and political causes.
In 2012, the USA passed the JOBS act (Jumpstart Our Business Startups), which made it legal for small businesses and start-ups to raise capital from unaccredited investors. Along with similar laws in other countries, this led to a dramatic increase in the number of investors who could help finance new ventures and the money has started flowing.
Fundable estimates that over 270,000 jobs have been created in the USA as a result. Forbes estimates that the amount raised via crowdfunding will exceed total venture capital investments in 2015. The Federal Reserve’s July 2015 report says that credit terms for small businesses were eased and competition from non-bank lenders was an important reason for this change.
The digital investment market offers huge opportunity to a wide variety of constituents. Crowdfunding for non-profits and charitable causes makes it possible for any individual worldwide with disposable income to give back to make the world a better place. Technology allows for better access, efficiency, and transparency. There is a huge network effect as people publicize their charitable causes and success in getting loans and equity investments, leading to more people investing and consuming.
Goldman Sachs estimates a $4 trillion addressable business market, including over $1 trillion for crowdfunding to SMEs, nearly $2 trillion in lending, and $400 billion in wealth management.
The Goldman Sachs report cites several specific examples of the huge growth at the infancy of this market:
- Lending Club: Over $10 billion in loans, mostly to individuals;
- Kickstarter: Over $1.6 billion raised for start-ups;
- Wealthfront, an alternative finance wealth management option, took 2.5 years to get it’s first $1 billion under management, then just 9 months for another $1 billion. The average account size is under $10,000 (compared to over $250,000 at Charles Schwab).
Other evidence of explosive growth is in the news almost weekly. Recent announcements include:
- Prosper reaching $5 billion in loans, up from $2 billion a year ago;
- Pozible’s platform has launched 10,000 projects with $40 million pledged;
- SoFi raised a $1 billion equity investment for their online lending platform, the largest financing round in FinTech history. They have funded over $4 billion to date and expect to lend another $2 billion in the next 3 months.
Morgan Stanley recently projected that the global marketplace for peer to peer lending will reach almost $300 billion by 2020.
Many people refer to crowdfunding and peer to peer lending as the “socialization” or “democratization” of finance because of the participation of huge numbers of individual investors. However, the growth in digital investment is not being funded just by individual investors. Institutions are increasingly investing capital in debt and equity offerings funded through the alternative finance market. In addition, there is massive investment in technology companies providing the underlying infrastructure and data to enable the digital investment businesses as well as the investment platforms such as SoFi as mentioned above.
Often new technology results in massive disruption to a traditional market. For example, the major music labels have seen their revenue decrease by over 50% since the introduction of MP3 and other digital music services. In the case of finance, we are seeing as much collaboration as disruption, as the existing players have massive amounts of capital and are always looking for an opportunity to put that capital to work for the best return given the relative risk. Instead of fighting change, the digital investment landscape offers new opportunities to traditional players and this support is expected to accelerate and help drive market growth. That seems like a smart decision, given that it can take only 10 minutes to do an on-line loan application and traditionally that was a 25 hour process with a bank.
Warnings for Borrowers
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Alternative Finance and FinTech offer great new opportunities for companies and consumers who need cash. But, anytime you are going to borrow money or sell part of your company, you should be cautious and make sure you fully understand the financial deal you are about to complete. Here are a few tips that apply specifically to alternative finance loans.
Compare Interest Rates
Now that there are hundreds of websites offering alternative financing, it is important to compare the cost. In some cases, interest rates are very low (5%) and comparable to what a bank would charge. Even with these low rates, it may only take 30 minutes to compare offers from several sources and find one that is 10% to 30% less expensive than others.
If you have bad credit or non-bankable credit, the interest rate could be much higher. Stated interest rates can run from 12% to 25%, similar to what you pay on credit cards. Implied interest rates can be 50% to 100%+. Compare interest and implied interest rates on different types of loans from at least 2 or 3 providers of each type of loan to see what gives you the lowest cost. Consider contacting a Broker who provides different types of financing to see what they think is the best alternative for you.
Even if you are only borrowing $10,000, the cost difference could be huge, from $500 to $5,000 or more. If you spend 4 hours of time looking at different options, you might find you save over $1,000 per hour for that effort by finding a lower cost solution.
Understand Implied Interest
Many of the new finance options do not include an interest rate. With a merchant cash advance, revenue cash advance, or invoice factoring or selling, you are exchanging future revenue for a discount to get cash today. The small daily payment may seem very affordable and you may be inclined to move forward. But, when you look at the cost, you may learn that the implied interest rate is 50% to 100% or more per year.
For example, with traditional invoice factoring, invoices often are sold for a 5% discount. If your customer normally pays on time at net 30 days, then when you factor the invoice you are borrowing money for only 30 days. So the 5% discount is equivalent to a 60% interest rate: 5% x 365/30 = 60% . Or, think of it another way. If you factor a $10,000 invoice once a month, you do this 12 times per year. If you are giving up $500 on each invoice (5% of $10,000), then for 12 months that is $6,000. In this example, you paid $6,000 in implied interest to borrow $10,000 for a year, which is an implied 60% interest rate.
Merchant Cash Advances (MCA) have similar economics. Let’s say you sell $28,000 of future credit card sales for $20,000. The amount of implied interest you are paying is $8,000 ($28,000 – $20,000). With an MCA, you agree to pay back a fixed amount per business day. Let’s say your business is open every day and the fixed amount to pay back daily is $76. That means you expect to take a full year ($28,000/$76 = 368 days), so your implied interest rate is $8,000 / $20,000 = 40%. But, if the lender says the fixed daily payment is $100, then you are only borrowing the money for 280 days ($28,000 / $100 = 280). So the implied interest rate is actually $8,000 / $20,000 x 365/280 = 52%. You can use the form below to calculate the implied interest rate for an MCA.
To make matters worse, most MCA providers tout that there is no pre-payment penalty for paying off the debt early. But, you don’t get any discount for paying back early. In this example, you still have to pay back the full $28,000, whether you do it at the daily fixed rate or pre-pay. So, by paying back early, the implied interest rate is even worse. In a case like this, you should never pay back early, because if you suddenly have a cash flow shortage, you may need to borrow again and pay more interest.
Read The Fine Print On Daily Payment Amount
The Buyer of your future receivables is likely to tout that the amount you pay daily is based on a specified percentage of your actual daily revenue, especially with Merchant Cash Advances. Some Buyers directly tie the payment to the amount you receive from your credit card processor each day, so the payment amount truly fluctuates with revenue. That is preferred, so if sales go down, which creates a cash flow problem, at least your daily payment amount also goes down.
However, other Buyers state that a fixed amount will be taken from your bank account each day regardless of actual credit card sales. Then, at the end of the month, if your actual receipts were less than anticipated when you initially got funded, you can ask for a refund. Obviously, when sales are less than normal you will have cash flow issues. This approach of paying the fixed amount daily and then getting a refund of excess payments 30 to 60 days later just makes your cash flow issues worse. So when possible, get an advance tied to actual revenue, not projected revenue.
Make Sure You Really Should Borrow
Let’s say the only financing you can get for your small business is an MCA or similar Revenue Cash Advance (RCA), and you have estimated the implied interest rate is 50%. Does it really make sense to borrow the money? The answer is “yes” if you can earn more than 50% by how you are using the money.
Let’s say your retail store really needs a makeover that is going to cost $20,000. You can get an MCA loan by selling $28,000 of future sales. You hope that when the store has the new look, you can sell an extra $1,000 of goods each month where you make a gross profit (sales price minus cost of the item sold) of an extra $500 a month. The MCA is going to cost you $8,000, which means it is going to take 16 months making an extra $500 a month just to earn back the $8,000. Are you sure you want to do this?
Sometimes businesses get offered a great deal on excess or close out inventory. Let’s say you can buy $30,000 of inventory for $20,000. But, if you have to sell $28,000 of future sales to get the $20,000 in cash to buy this inventory, in the end you aren’t going to be better off.
If the implied interest rate on your borrowing is 50%, you should be sure that the investment opportunity you are going to complete with the borrowed money will give you a 100% return. That way even if things don’t go exactly as planned, you still should have a good chance of making a profit from borrowing the money.
Be Careful of a Downward Spiral
We frequently see cases where a small business has been losing money for a long time. The owner has invested all their savings into the business. They have borrowed from friends, family members, and on their credit cards. Now they are considering an alternative finance loan.
But, unless you know you can take the borrowed money and somehow fix the problem that is causing the business to lose money, why borrow more? This just digs a deeper hole. Let’s say your business depends on the health of the oil industry, something you have no control over. With oil at $50 per barrel, this industry is not going to improve until the price of oil increases substantially. Right now there is no indication this is going to happen in the next year or two. So, to borrow money to keep your business going another 3 months doesn’t make any sense. You just dig a deeper hole. Instead, it is time to start a different business or get a job to stabilize yourself and then look for a new entrepreneurial opportunity.
If you are looking to borrow personally, make sure it is just to get you over an unexpected problem. If you are short money every month, then the real solution is to either cut expenses or increase your income. Borrowing just digs a deeper hole.
Don’t Borrow To Pay Off Other Debt, Unless…
Unless you are going to save money, it’s almost never a good idea to borrow from one place to pay off another debt. Especially if your new debt has a very high stated or implied interest rate.
If you can borrow money that truly has a lower cost than your current debt, then taking out a new loan makes sense. Otherwise, it is better to just deal with the current lender and find out what is the best option for both sides.
For companies that have fallen behind on their accounts payable to suppliers, borrowing from an alternative financing source to pay off vendors can make a lot of sense. You need to keep buying merchandise from your suppliers and they won’t ship if you are past due. So paying off past due bills so you can get new product to sell and make profit is a probably a good decision.
There is one other time when it can make sense to borrow from a new source to pay off an old one: when you can negotiate a dramatic reduction in the old debt. Let’s say you owe $10,000 on a credit card and they are charging you 30% interest and you have not even made your minimum monthly payment for a long time. Perhaps you can get them to agree to just take $5,000 as settlement in full.
Or, maybe you have 5 credit cards, each with $10,000 past due, so you owe $50,000. Let’s say you can borrow $7,500 in new money. Call all 5 of the credit card companies and offer each one $2,500 to pay off the $10,000 you owe them. Explain that the first 3 companies that take this offer will get the settlement and the two that don’t won’t see any money from you until you pay off the new $7,500 loan. If you get 3 takers, you have settled $30,000 in debt for $7,500 and you are a lot better off.
If you do negotiate a debt reduction, make sure you get something in writing that confirms the settlement deal before you pay if off. If they won’t put it in writing, then it isn’t a real offer and you are not getting a discount. You’ll be in an even worse position.
Don’t Commit Fraud
We frequently get claims from MCA lenders against their borrowers who switch their merchant account (e.g. the credit card processing account they use at their business) so that the MCA lender no longer gets their daily share of credit card sales. Many of the agreements make the business owner personally liable when this happens, whereas they may not have had to give a personal guarantee to get the MCA. It can also be considered fraud. If this ever goes to court and the judge agrees you committed fraud, the amount you owe cannot be discharged in bankruptcy. This means that someday, no matter what happens, you are going to have to pay it back, along with interest that keeps building.
Many alternative finance lenders also have you agree to pay huge penalties if you turn off the daily ACH access, change your merchant account provider without notice, or change the bank account where your credit card receipts go. We have cases where there is a $2,500 default fee, $2,500 fee for blocking ACH access, and you to pay the collection agency fees which typically run about 20% of the amount owed. We’ve seen cases where the borrower only has $10,000 of our client’s money, but now owes nearly $25,000 and facing a possible fraud conviction. Don’t make this mistake.
As a collection agency, we always prefer that our clients get personal guarantees, whether it is on a loan, alternative finance product, or simply a trade payable from the guarantor’s small business. Historically, it was almost impossible for a small business owner to get a loan without giving a personal guarantee. But in the world of alternative finance, we see businesses getting funding all the time without the owner’s guarantee. So shop around and compare not only the cost of money and repayment terms, but other terms including possible personal guarantee requirements.
What To Do If You Have Problems
See this article for advice on what to do if you have problems. The key things we emphasize are communicate, be honest with yourself, and don’t make matters worse. If you play ostrich (e.g. stick your head in the sand and pretend nothing bad is happening), you lose control and it can lead to the worst set of circumstances. You also want to avoid the mistakes mentioned above. If you can’t figure out how to deal with the problem, hire professional help or get help from free resources in your community.
While we have discussed several issues to avoid, in no way are we saying alternative finance is bad. In fact, we think FinTech and alternative finance creates great opportunities for borrowers and lenders. Just be careful. If you are going to borrow, make sure you understand the cost. And don’t make the easily avoidable mistakes mentioned above.