A Cautionary Tale of a Small Merchant’s Loan Gone Wrong

Thursday, August 27, 2015

The world is full of promise when you’re a young entrepreneur fresh out of college. It’s full of peril, too, as I soon found out.

After graduating from Washington State University, I launched several restaurants and bars in the Seattle area. That same year, a rep for a cash advance company walked into one of my establishments—the beginning of a very tough road. The rep offered me a preapproved $30,000 cash advance, and I accepted it without proper due diligence.

Before I get into the details of my experience, let me give you a little history on merchant cash advances. This alternative lending space for businesses became mainstream in 1998—offering the purchase and sale of a future receivable at a discount. The advances are structured in order to avoid state usury and lending laws, and they vary by state.

While the repayment method works well for seasonal business owners (percentage of their daily settlements), the rates are usurious and merchants have historically paid in excess of 100 percent APR.

Without doing the necessary research—you couldn’t even “Google” it back then—I was an easy target. The rep was persuasive, explaining that the repayment was simple and automated. The only catch seemed to be that I would need to change credit card processors—which happened to be a wholly owned subsidiary of the company offering the cash advance. In retrospect, a red flag.

The simple part of the process was supposed to be the 20 percent of my daily Visa and MasterCard settlements. I remember it vividly. The rep said “Don’t worry, we will charge you the same credit card processing rate that you currently pay”—which clearly ended up being an empty promise.

With this particular model, how can a business with smaller margins pay their bills if they are giving 20 percent of their daily Visa and MasterCard settlements to these cash advance providers? Obviously, the answer is you can’t, and it resulted in numerous “going out of business” signs in many storefront windows.

Unfortunately, the reality had settled in, and I had to face it—I needed to pay the $30,000 advance. Enter the real problem. It ended up not being the “$30,000” that I was advanced. In actuality, they had purchased $42,000 of my receivables, which was a total of the 20 percent of my daily settlements and an interest rate. Of course, the rep never brought up the term “interest rate,” so at the end of the day I was responsible for the full amount—and it needed to be paid over the next six months.

The repayment window was determined after they evaluated my statements from the last three months. It was typically six months back in those days. Assuming I stayed in business, not bad for the company offering the cash advance—collecting a 40 percent rate over six months is 80 percent over one year—and a true APR of 160 percent once you account for average unpaid daily balance.

Their model had plenty of margin to cover the merchants they were putting out of business, and I refused to become one of their statistics. Needless to say, the experience left a very bad taste in my mouth. So when an acquaintance called me in 2004 to pitch a new job opportunity—you may be surprised by the offer, but not my reaction.

Life is all about timing, and since I was in-between projects, I listened. The acquaintance informed me about a startup lending business looking for a sales manager. Ironic, yes, but they were offering a hefty salary, stock options and an override. During the interview, I soon realized they wanted to emulate the cash advance model that I had been burned by in the past.

With 1999 still fresh in my mind, I turned it down because it was against everything I believed in. Instead, I decided to continue my entrepreneurial endeavors by building a lending business the right way. I would distinguish my business from others by creating a web-based daily loan tracker so borrowers could track what they owed at any given time.

Next, I decided to take a completely different philosophical approach. I essentially deterred customers from borrowing from me. Instead, I listed all the options on how to raise their business’s equity, instead of incurring debt. There were several instances where I actually talked them out of using my product, and they ended up getting capital from their current bank.

Even though my rates were far less than the competition, it was very important to me to be fair and ethical after my experience. I know they appreciated the candor.

From day one, I worked solely on a referral basis—working with a person who happened to be my current Heartland representative. She started referring leads and expanded my network of Heartland reps across the West Coast. That eventually led to my introduction to Chairman and CEO Bob Carr—the heart of Heartland.

In typical entrepreneurial fashion, Bob reached out to me in 2006 because he had heard that I was different and was attempting to lend money in the right way—the Heartland way. In our conversations, he explained that Heartland wouldn’t charge more than a 30 percent APR or 7.5 percent interest rate over six months.

Although I was aligned with Heartland on the ethics and rates, Wall Street didn’t see things my way. After many high-level meetings with hedge funds, they all ended with the same result: “You aren’t charging enough. Go back to Heartland and tell them you need to charge your customers more.” I knew that Bob and Heartland wouldn’t go for it and that it would be a nonstarter. I was stuck.

I was only able to make a few loans with equity during 2008 and 2009, but couldn’t seem to close on a significant credit facility or debt. Not to mention, trying to raise capital during the recession didn’t help matters either.

Finally, toward the end of 2009, I had a call with the then-CEO of OnDeck. We concluded that his company had capital and Heartland had viable leads. We launched a pilot in May 2010 and began making loans to Heartland customers at well below the market rates, and below the typical OnDeck rate. We were finally able to get some traction.

So what is the moral of this story? Be sure to do your research. Make sure you understand every aspect of the deal that a cash advance provider is offering you. Work with a reputable, trusted resource to discover what your best options are.

If you’re looking for a trusted partner who has developed the best lending solutions in the market and will get your small business the funds you need when you need them—at the most reasonable rates possible—Heartland may be a good option.

Heartland is a great advocate of small to mid-size merchants. We also started working with American Express (AMEX) in 2013 and they offer one of the best deals in the market.

Click here for more information on Heartland’s Lending Solutions.