With bank loans still eluding many small businesses years after the global financial crisis, new online services are sniffing out opportunity to fill the gap in the credit marketplace. Some of the newest options are loans or advances on money your business is likely to receive each month, making it relatively easy to finance big purchases such as holiday inventory. They include Kabbage, PayPal Working Capital and American Express Merchant Financing.
The trend is a twist on the centuries-old financial practice known as factoring. In factoring, you sell your accounts receivable or invoices to a factoring company, which advances you a percentage of the value of the invoices -- usually 70 percent to 90 percent. After your client pays the invoice, the factoring company takes out a transaction fee and then sends you the balance. Because of the transaction fees, factoring usually isn't worthwhile for businesses with lots of small invoices.
The new services differ from factoring in that they are not based around a particular invoice. Rather, they look at how much money you historically bring in through a given payment source and advance you cash based on your likely ability to repay.
While options like these can help you in a pinch, it's important to understand how much you're really paying for the money, says Nat Wasserstein, who advises distressed companies as principal at Lindenwood Associates in New York.
When you consider loans that require you to pay back a small percentage of your receivables every day, week or month, it can be hard to make an apples-to-apples comparison to other forms of alternative financing, such as using a credit card, where the average APR on a business card is currently 12.98 percent, or to traditional bank loans, where the average interest rate is about 8 percent.
The receivables financers typically charge a set fee based on a number of factors, including your repayment rate. Be sure you understand what that fee is before you sign on.
Also watch out for a common hazard of loans and advances where sometimes the lender begins extracting payments from your receivables before you even have time to touch the receivables yourself. If your cash flow is already tight, the automatic withdrawals can leave you short of cash to run your day-to-day business. "It can get to the point that you're like a hamster on a hamster wheel," says Wasserstein.
Comparison shop for the best deal
Despite these potential downsides, some merchants are finding the new types of receivables financing convenient when they lack other, less expensive options.
Richard Dunn turned to Kabbage to finance inventory at his 6-year-old business, Western New York Liquidators, which sells clothing and other liquidated goods on eBay. Because his $45,000 to $65,000 in monthly receivables come in through PayPal and he is buying liquidations -- a type of purchase that is traditionally hard to finance -- his bank turned him down for a traditional loan. "Banks will not even look at your PayPal account," he says. "They'll say, 'Where is your income?'"
Early in 2013, Dunn took a $10,000 advance through Kabbage to help him buy five truckloads of returned items from the Company Store. He has since used his Kabbage account as a line of credit when needed. He can have a total of $25,000 on loan at any given time and Kabbage extracts monthly payments toward each advance. "They understand the Internet business better than banks do," he says. Since more than 99 percent of his business income arrives via PayPal, it seems to be the most convenient option for him, he says.
Kabbage isn't just for retailers financing inventory. While it offers advances of up to $50,000 to merchants who have accounts with eBay, Amazon, Yahoo!, Etsy and Shopify, it also works with service businesses, manufacturers and tech firms. "Before, we used to skew very high toward e-commerce," says Treyger. "Now we're seeing people use Kabbage funding for things like payroll and hiring staff."
When Kabbage makes an advance, it charges a fee of 2 percent to 10 percent of the borrowed sum on the first two payments and then 1 percent on the last four payments, with the typical advance lasting about four months. The rate is determined by a company's "Kabbage score," which takes into account factors like revenues, shipping and e-commerce volumes and payment history, as well as the company's volume of receivables.
Customers can either pay Kabbage directly or have the company deduct one-sixth of the due amount from their checking or PayPal account.
What'll it cost you? For the typical customer, the fee is about 14 percent over six months, according to Victoria Treyger, chief marketing officer. That means someone who borrowed $50,000 for six months has to pay back $50,000 plus $7,000.
Kabbage isn't the only option. Another choice for PayPal users is PayPal Working Capital. It enables qualified merchants to get an advance of approximately 8 percent of the PayPal receivables the business processed over the previous 12 months -- up to $20,000 -- from WebBank, an industrial bank that has teamed up with PayPal. WebBank looks at the merchant's sales history to determine the maximum amount of the loan. The minimum loan size is $1,000.
Merchants pay back the loan by giving WebBank a cut of their daily PayPal sales. They choose upfront to make payments of 10 percent, 12 percent, 15 percent, 20 percent or 30 percent of their PayPal receivables, with payments automatically collected from their PayPal account until the loan, plus a fixed fee, is repaid. The repayment plan they choose can have a big impact on the fee size. A business with $100,000 in PayPal sales that borrowed $8,000 would pay a fee of $281 if it opted to repay the loan with 30 percent of its daily receivables, according to PayPal. However, the fee would more than triple -- to $947 -- if the merchant chose 10 percent instead.
During periods that a business has no sales through PayPal, it pays nothing (as long as the business is not deliberately directing payment volume away from PayPal). Businesses are allowed to repay extra or pay off the loan in full without penalty.
For businesses that mostly accept credit cards, another possibility is American Express Merchant Financing, available since 2011. It enables merchants who make $50,000 to $10 million in annual sales -- either on AmEx cards alone or on other major cards, too -- to get commercial loans from $10,000 to $750,000 for a fee as low as 6 percent. AmEx extracts a percentage of the merchant's estimated charge volume each month to pay back the advance in the time period of the loan.
AmEx tailors the terms of the deals to the merchants' track records in generating cash on AmEx cards. "We see that they've had American Express business for years," says Ed Jay, senior vice president of the American Express U.S. Small Merchants Group. "That allows us to have a different view into the stability of these businesses."
Currently, American Express offers two products, a monthly one and an annual one. A merchant who borrowed $100,000 using the annual product would generally pay a 6 percent fee -- $6,000 in total -- that he would repay during the 12 months of the loan. For the monthly product, the financing fee can be as low as 0.5 percent per month -- meaning that on a $10,000 loan, the minimum fee would be $50.
If the merchant pays off the loan early, either by writing a check or because his charge volume is higher than average, AmEx would offer an early repayment rebate. For instance, if he paid the loan off in four to six months, AmEx would rebate 50 percent of the total fee. If a merchant cannot make at least 80 percent of the payment, AmEx has the right to debit the balance from his merchant bank account.
Other options available
Before trying one of the new alternative financing options, it's important not to rule out bank loans and other options too soon, say experts. One option that many businesses neglect is going to a smaller bank for a traditional loan. In October, Biz2Credit reported that big banks approved 14.3 percent of loans processed through the site, a matchmaker between borrowers and lenders, while small banks OK'd 44.3 percent of loans.
"Look at the small banks no one has ever heard of," advises CPA Richard Levychin, a partner in KBL LLP in New York City.