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Another Voice: Regulators are destroying a lifeline for small businesses

By Rusty Weiss

Starting and running a business is a blood sport. Just half survive their first five years. Only one in three makes it to year 10.

When disaster strikes — sales dip, equipment breaks, a crucial salesman quits — most small businesses have no choice but to close. They’re running on razor-thin profit margins as it is — and most have little savings. Making matters worse, banks typically avoid small businesses.

Thankfully, because of advances in financial technology, there are new service providers catering to small businesses. These providers offer “merchant capital” — essentially, cash advances on future earnings. The advances cost more than traditional loans but have helped thousands of small firms in times of need.

But in state legislatures across the country, some powerful lawmakers are campaigning to squash this nascent industry. Their efforts would destroy this lifeline.

Banks have always been wary of lending to small businesses. Such loans tend to be much riskier and less profitable than loans to larger, established companies. And the 2008 financial crisis made banks even more risk-averse: An analysis from Harvard Business School shows that bank loans to small businesses are down about 20 percent since the crash.

Meanwhile, most small businesses are in a financially precarious position. Even if they’re making a profit, few have accumulated enough savings to absorb big unexpected costs.

Enter merchant capital. The provider evaluates the business’s expected revenues to determine the size of the advance. Importantly, most merchant capital firms don’t consider credit history. For many small businesses, that would be a deal-killer; they had to load up on personal debt in their early growth stages. Providers don’t require collateral, just a “performance guarantee” legally committing the owner to try her best to pay back the advance.

Merchant advances, which typically range from $10,000 to $500,000, are repaid through automatic deductions from a firm’s sales.

That’s another key distinction from traditional loans. Rather than requiring a borrower to pay a fixed amount on a preset schedule, merchant capital providers tie re-payments to performance — they’re lower when sales are down and higher when sales are up.

Since merchant capital firms are exposing themselves to the possibility that the small business won’t hit its revenue projections — a very real risk given the high rate of failure in this sector — advances come with higher prices than traditional loans.

Critics fixate on those prices, but most businesses are glad to pay them. The quick cash is a godsend: it gives them a chance to survive. Without it, they’d have no choice but to close.

Some state lawmakers have failed to appreciate this calculus and remain convinced that merchant capital is too expensive. Several are trying squash the industry entirely.

New York Gov. Andrew M. Cuomo, for example, has silently slipped a provision into his newest budget proposal dramatically ratcheting up controls on merchant capital firms, including expensive, time-consuming licensing requirements. And the California state legislature is about to pass untested rules restricting industry marketing.

If written into law, these bills would saddle merchant capital providers with excessive costs and drive many out of business. America’s hard-working entrepreneurs would be denied an important financing option when trying to survive tough times.

Rusty Weiss, of East Greenbush, is editor of The Mental Recession, a conservative news site.

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