On the TV show “Shark Tank,” business owners typically ask for funding in exchange for equity. When a product catches the eye of Kevin “Mr. Wonderful” O’Leary, he likes to counter with a complicated deal consisting of royalties and fees. Sometimes royalty in perpetuity comes attached to the offer. Smarter entrepreneurs turn him down flat because it takes away money they could reinvest in the business.

To explain O’Leary’s type of deal, take a look at the deal he made with Wicked Good Cupcakes. They sold cupcakes in a jar for $7.50 each. O’Leary offered them a deal in which they would have to pay him back $1 per jar until he recouped his money. After that, they would pay him 45 cents in royalty forever.

That means the company only gets $6.50 per sale. Not all of that is profit as part of that includes the cost to make the product. After O’Leary gets his investment back, then Wicked Good Cupcakes can only get $7.05 per product for the lifetime of the business with Mr. Wonderful keeping 45 cents.

How does merchant cash advance work?

Merchant cash advances (MCA) aka business cash advance work similarly to a royalty deal except they replace royalty with high interest fees. They’re like payday loans for businesses. MCA providers offer a lump sum payment in exchange for future sales with a very high interest rate.

They get a piece of every credit or debit card sale. For B2B companies and others without credit and debit card sales, an MCA provider withdraws the money straight from a PayPal or bank account. And like an O’Leary deal, they tack on fees. Instead of royalties, it’s interest rates that are 50 to 100 percent higher than a bank’s. Let’s say a small business gets $50k from a MCA provider.

The provider withdraws a percentage from the business’s credit card sales or PayPal account every day or every transaction. This continues until the business pays back $75k ($50k plus 50 percent interest).

No business can be certain that sales will consistently come in. So what happens when they have a dip in sales? An MCA can eat up all of the profit and potentially put them in debt. Some providers may work out a deal in which they take less money on slow sales days and more on higher sales days. In the end, the business finds that when it has paid off the loan, it needs working capital again.

Unless a business can grow sales immediately with this extra working capital, their cash flow will be worse after it pays off the loan. It is a Band-Aid, not a long-term solution to grow your business.

The problem with MCAs

Owners can’t help but become MCA addicts when the business doesn’t pay off the business cash advance quickly. As a result, the small daily debits pile up that the business takes out another loan to cover themselves. And another.

How do businesses get out of the merchant cash advance vicious cycle?

• They don’t. They keep renewing these loans.
• They borrow from savings to pay it off.
• They absorb it as part of gross margin.
• They default without filing Chapter 11.
• They file Chapter 11.

An MCA loan averages around $50k, an amount that most businesses can handle — for a little while. Then the business gets in over its head when the MCA provider keeps withdrawing money. Some change their bank account to prevent the MCA company from withdrawing the money. The MCA provider sues. That’s why they keep the loans small. It allows them to diversify and absorb the high rate of loan defaults.

There’s nothing illegal about merchant cash advance. Visit MCA providers’ websites. You wouldn’t think they’re shady or scrupulous. In fact, they look downright helpful and even receive a good grade from the Better Business Bureau. They don’t always state they do MCAs. They reference their financing plans as business cash advance or small business loan.

While they disclose a fee that looks reasonable, they don’t mention the APR, which averages around 50 percent. They also don’t mention all the possible fees, such as origination fees, hold back fees and payback or interest rates. Here are questions to ask about getting a business financing or a loan.

Search for “[MCA company name] complaints” to see what past customers have to say about working with these companies.

Why your business needs a Plan B

Here’s what could happen that calls for a Plan B.

Your cash flows well and your sales are stable.

What would happen if …

• Your sales dipped by 10 percent or 20 percent for a few months.
• One of your customers starts paying you 30 or more days slower.
• Your main vendor starts requiring COD.

These events could happen without a moment’s notice and for reasons unrelated to your business. This leaves you with no time to scramble and try to get a line of credit from a bank.

You know your company is valuable. It’s the source of income and perhaps retirement. It also supports all your staff and many customers. It would be a shame to jeopardize all you have built simply because you don’t have a Plan B.

Using Capital Solutions Bancorp (CSB) as your Plan B, you get 100 percent certainty of success. Even if any one of these catastrophic events happen.

Think of CSB as your insurance policy that gives you the peace of mind that none of these otherwise catastrophic instances will topple your company or make you lose a single night of sleep.

It’s high praise to finance your company on its own cash flow. Just like you wouldn’t drive a car without insurance, you’d insure your business with a Plan B in case cash flow gets bumpy.

You get where you want to go in the most efficient way. When you are ready for the next step in your financing life, then CSB celebrates your accomplishment and wishes you well.

No one complains to a taxi driver that a taxi is more expensive than taking the bus, right? People that take the taxi take it because they have a specific goal in mind and want to get there in a specific way. It’s NOT their only or final way of transportation — they might have their own car — it’s a temporary means for getting them where they want to go.

A better option to get working capital

Unlike an MCA provider and Mr. O’Leary, CSB doesn’t take away any money before it comes to you. You get the money your business has already earned. Capital Solutions Bancorp is a flexible funding organization that takes care of your invoices along with the risk that comes with nonpayment. So there’s no paying back anything.

It’s easy to apply when a business meets the basic funding requirements:

• You’re a B2B company that does business with other businesses.
• Your business has more than $1 million sales every year.
• You have invoices for getting receivables.
• You don’t bill medical insurance companies, Medicare, or Medicaid.

You can choose which invoices you want funded and continue using your line of credit. If your company is growing, you get certainty of success that regardless of your rate of growth or whether you have a bank that already provides you with financing. Working with CSB, you won’t need to worry about managing your cash flow.

What if your company is not growing? If your company is stable, cash flow is moving along OK or you have a small line of credit — you must have a Plan B. Having no Plan B is like jumping out of a plane without a parachute.

Let’s put it another way. Would you buy an insurance policy for your car or home where you only pay the premium on what you use?

Of course, right?

That’s what Capital Solution Bancorp does for your cash flow. Contact us today. No obligation.

Image credit: adamci