Most small-business owners dream of seeing orders quintuple overnight. But when Fern Phillips had a purchase order suddenly jump from 4,000 units to 20,000, she knew she had to scramble for an extra $20,000 to buy ingredients. "It was a panic," she said.
Phillips had used traditional bank financing to start Portsmouth, N.H.-based Little Big Farm Foods, which develops and manufactures all-natural dry baby mixes for private-label customers. But this time, she and her partners, Gus Bybee and Ashley Bush, were rejected by their bank as well as community banks. "I thought we could get purchase order financing," Phillips said. "We were looking at each other, going, 'Now what do we do?'"
That's when Phillips got a Facebook message suggesting she check out Pawntique, an online pawn shop. Phillips emailed Pawntique about her family silver, which the company valued and accepted. "I would have shied away from something like this in the past, thinking I was going to be judged as being a bad businessperson," Phillips said. "But it was very smooth, very professional. It was a godsend."
A growing number of small businesses are tapping alternative funding sources such as online pawn shops and merchant cash advance providers, which provide a safety net for business owners rejected by banks but can also bring higher interest rates or more risk than traditional bank financing. Phillips said she believes entrepreneurs are turning to alternative funding because "there's a huge gap between small businesses and banks. Big banks have the money -- they're just not lending it." Although she was glad to find another option, banks shunning a growing business "is sad, really," she said.
According to Pawntique's founder and CEO, Don Battis, his clients -- half are businesses -- have pawned silver flatware, fine wine collections, even fine art. He said demand has increased with the popularity of pawn reality TV shows, but also because pawn shops are becoming more respectable. "Instead of just small mom-and-pop stores, these are publicly traded, professionally managed, upscale merchandising companies," he said. The clientele, he added, is also changing from the days when pawn shops mostly served the unbanked. "I don't know if any of our customers have even been to a pawn shop," he said.
Pawntique basically works like a storefront pawn shop, except it's exclusively online. Customers send Pawntique a description and photo of their items, receive an initial value estimate via email, then FedEx the item to Pawntique for a final appraisal. Customers can receive their money "in as little as 24 hours," Battis said. "They like the fact that we make a decision quickly, it's through the Internet and it's confidential."
Phillips received $20,000 three days after initially contacting Pawntique. The interest was 3 percent monthly over a three-month term. She saved some of the interest by repaying the total amount a little early. "I basically paid $10 a day," Phillips said. "It allowed us to produce the product and make the profit. Without it, I don't know what I would have done."
NIGHTMARE OR SAVIOR?
Many small-business owners who need money to thrive -- or simply survive -- are tempted by the easy approval and minimal paperwork that alternative funding sources offer.
"The alternative funders are providing a valuable source of funding for small-business owners," said Ami Kassar, founder and CEO of Philadelphia-based MultiFunding, which helps small businesses find loans. "I wish they were cheaper, but in many cases they're providing life to businesses that desperately need it and can't find money anywhere else."
But that lifeline can sometimes feel like a noose. "I felt like cash advances were frowned upon as not a legitimate way of borrowing money, but how else was I going to get it?" said one Dallas restaurateur, who took a cash advance and asked not to be identified. She considered a merchant cash advance "a last resort. But at least they're there for you when you need them."
Although her company had annual sales of $750,000 to $1 million in the nine years since she started her fine-dining, dinner-only restaurant, business dipped during the recession. Her recovery plan: Get a bank loan for $25,000 to lease the vacant space next door and serve value-oriented breakfast and lunch without compromising her original brand.
But she was rejected by both big and small banks, which said her profit and volume weren't high enough. "If I ever write a book on how to open a restaurant, the first chapter is going to be 'Banks Are Not Your Friends,'" she said. "There was not an ounce of leeway, in terms of looking at my situation and what I had built. We've been on the Food Network and in Travel & Leisure, earned top chef awards and maintained in one of the worst economies, and they won't loan me $25,000?"
In August 2010, she decided to get a merchant cash advance, which she calls her "nightmare/savior." For years, she had gotten emails, letters and calls from merchant cash advance providers clamoring to give her cash upfront in exchange for a percentage of her future credit card sales. "I thought, 'Who would borrow money based on future sales? That's insane,'" she said. "I was sick to my stomach the first time I did it."
To get $25,000 in cash, she agreed to pay back a total of $36,000, with the merchant cash advance firm skimming 12 percent of her daily MasterCard and Visa sales until the $36,000 was paid in full. "I thought I would pay it back quickly," she said. But she wasn't able to open her adjoining restaurant when she expected. In early 2011, she got a call from another merchant cash advance service offering her the money to pay off her loan, plus another $20,000. "Before you know it, you're borrowing $40,000 instead of $25,000, and the interest rate goes up to 15 percent," she said. "It's a vicious cycle."
Merchant cash advance firms are benefiting from both increasing awareness and growing need, according to David Goldin, president and CEO of New York-based merchant cash advance provider AmeriMerchant as well as president of the North American Merchant Advance Association , which represents the 17 merchant cash advance providers that make up 95 percent of the industry. "If banks were lending all the day long, our sales would be down," Goldin said.
But sales are up -- Goldin reported that demand for merchant cash advances increased 15 percent to 20 percent in 2011. According to Goldin, the average merchant cash advance amount is about $20,000, and is usually approved within 24 hours and funded in a week or less. Most merchant cash providers charge 20 percent to 28 percent of the total amount loaned, and withhold 5 percent to 20 percent of daily credit card transactions as payment. That may seem like expensive money, but Goldin pointed out "it's less expensive than [offering] a Groupon for 50 percent off or putting inventory on sale for 30 percent off."
Golden said the big charges compensate the firms for big risks. "It's an unsecured product without recourse if the business goes out of business," he said. "Most people say it costs more than the banks, but we're lending to people that normally the banks won't."
Not only is demand growing -- supply is, too. There's a "surplus of capital in this industry," Goldin said. "Merchant cash advance companies have not reached the potential of how much they can fund."
Goldin said about 70 percent of his clients return for more money -- some as many as 25 times. "We don't force people to come back," he said. "The product just works. We're actually helping these businesses, not hurting them."
Phillips of Little Big Farm Foods, for one, is grateful. "In the short run, with the purchase order in hand, I knew we could reap the benefits of it and my silver would be safe," she said. She has since used Pawntique two more times. "As long as I know I can get the money back to them quickly, I'll do it in a pinch."
While alternative lenders meet the short-term needs of business owners, the long-term price may be too high for some. "It's fair to say that alternative funders have become a part of the mainstream Main Street lending culture," Kassar of MultiFunding said. "But I'm concerned that the high-interest loans will eventually create another bubble, and small-business owners won't be able to keep up in the long run."
Like Phillips, the Dallas restaurateur is an alternative funding repeat customer. Unlike Phillips, she's trying to break the cycle. "I wouldn't do this again," she said. "Once I pay back a certain amount, they start calling again, saying I've been pre-approved. It's hard, because you can always use another $15,000 as a small-business owner."
She is now about two weeks from opening her second restaurant, and estimated she has paid over $100,000 to do so. She hopes she can get a consolidation loan for $100,000 from a small bank. But "I'm setting myself up to be disappointed again," she said. "Merchant cash advances are a plan B. I hope I never have to go back to it. But I know it's there."