You may have recently read a popular article in Bloomberg Business titled “How Two Guys Lost God and Found $40 Million,” about the cash advance industry. The article caught my attention and quickly spread via social media to my family and friends, most of them part of the tight-knit Lubavitch community around the world.
The reason for our sudden interest in this business story was that the two “guys” who lost religion while building their fortune grew up in Ultra-Orthodox Jewish communities in Brooklyn. The writer even referred to one of them as an ex-Lubavitcher and claimed that the cash advance business was “invented” in a Crown Heights basement ten years ago by another Lubavitcher, Sam "Mula" Chanin. Chanin was a successful entrepreneur in the credit card processing business with a team of salespeople going store-to-store signing up merchants with the lure of the lowest rates in the business. In 2006, Chanin’s partner learned about another company that had started offering merchants cash advances based on their future credit card receivables. Chanin saw it as a massive opportunity for him and his business.
Sam "Mula" Chanin the "Don" of the cash advance industry (Photo Courtesy of algemeiner.com)
My cash advance addiction began in late 2011, when I took the first cash advance for my company, The Fresh Diet. I was well aware of the industry, as many of my friends and close associates had been in the business for years by then. In 2008, one of those friends let me use some desks and computers in his Madison Avenue offices for my new call center in New York. I spent months observing his cash advance business, and I was well aware of the risks. But before I tell you about my love-hate relationship with cash advances, I should explain how they work.
Although the cash advance business has evolved over the last 10 years, the basic premise hasn’t changed. A merchant is given an advance on their future credit card receivables based on their processing history. These “loans” are not guaranteed by anything but your future receivables; so if a company suddenly has a drastic decline in business, the repayments are paid back at the pace of the business. Unlike conventional loans, the monthly payment is not a pre-set number, but a percentage of future revenue. Cash advances are also not personally guaranteed (in most cases), nor are they tied to any assets of the business, making them high risk “loans” for the “lender,” who has little recourse if things go south.
One of the biggest allures for small business owners is how quickly a cash advance loan is closed. In some cases, funds can be received in days, and most can be received in weeks, which is a big part of the reason why desperate entrepreneurs and small business owners take on these high interest funding alternatives. While someone may be able to qualify for a more conventional loan— like a SBA loan or a line of credit from a bank—those loans take 30-90 days or longer to close. The quick turn around of cash advances is the active ingredient in the addiction. And it’s an addiction that can hurt the future of any business.
Cash advance rates are usually in the 20-36% range and are paid back within six months. The amount of funding is typically one month’s revenue; so a small business doing $100,000 a month in sales can quickly get $100,000 in funding, with a total payback of $120,000-$136,000. For the cash advance company to get paid back in six months, they would need to “hold back” roughly $20,000 a month or 20% of monthly revenue. In many cases, merchants need to take on more cash advances to keep up with the shortfalls caused by the initial advances. In those cases, the cash advance companies will make them pay off outstanding cash advance “debt” with new “debt.”
It’s a vicious cycle, and one I am very familiar with.
By the end of 2010, I needed extra capital to fund my annual January marketing push. My company had grown 100% over the previous year, and we raised our first round of capital from an angel investor earlier in 2010, but the company wasn’t in a position to make a large investment into marketing. For us to continue our growth trajectory, I knew I needed to invest at least $500,000 into a January direct mail campaign. Going to our bank wasn’t an option. They had already cut-off our small line of credit and, since banks usually won’t fund marketing initiatives, it was unlikely they would give us a loan. Our angel investor wasn’t an option either: we had just received our first investment, and we were hoping to look for another investment at higher valuation a few months later.
So I did it. Telling myself it would be a one-time thing, I took a cash advance for $500,000 against our Mastercard and Visa receivables. To talk my partners into it, I explained that our American Express receivables wouldn’t be affected; this was a great perk since Amex represented almost 50% of our revenues. Because I had a good friend in the business, I knew I would be able to secure the lowest rates and longest payback possible. And that’s exactly what happened: we received $500,000 by wire after only a few weeks of back and forth with Merchants Cash & Capital. No guarantees, no assets tied up, it was that simple. The funds came in right when we needed them, and I started writing checks to get our biggest marketing push ever off the ground. The marketing campaign worked as planned, and that January we had our best month ever. It kept our 100% year-over-year growth goals alive and doubled our run rate.
My gamble seemed to pay off. Yes, I paid a hefty fee for the capital, but it was money well spent because it gave us a fighting chance to keep growing our business. As the months went by, our company continued the 100% year-over-year growth, and we were paying back our cash advance on schedule. As a fast growing company continuing to invest in our infrastructure and technology, we counted heavily on our cash flow, so not having 100% of it was hurting us, but we felt we had the growth to raise some more capital from our investor. I began to focus on the raise and quickly forgot about the cash advance. Then came the summer of 2011. It wasn’t pretty.
To be continued……..
The story was slightly changed.
The time-line was off by 1 year and updated with correct history from 2011 to 2010 and 2012 to 2011.
Due to the timeline mistake, I changed that we grew 100% in 2011 for the second time in a row to, in 2010 we grew 100% year over year over the previous year.
