$30,000 by tomorrow, repaid daily from my sales. Lifeline or trap?

The question

An illustrative letter.

The answer

My dear, a slow summer is hard on any shop, and an offer of $30,000 by tomorrow must look like a door opening. I spent decades in lending, and I want you to walk through that door with your eyes open. Fast money is rarely cheap money, and the way this kind of offer is described, a small amount taken each day, is designed to make it feel smaller than it is.

What exactly is being offered?

This is usually called a merchant cash advance. Strictly speaking, it is often written not as a loan but as a purchase: the company buys a share of your future sales at a discount. You receive $30,000 now, and you agree to repay a larger fixed amount, collected automatically from your bank account or your card sales every business day until it is paid.

The cost is usually expressed as a factor rate, a number like 1.3 or 1.4. Multiply it by the advance and you have what you will repay. At a factor of 1.35, $30,000 becomes $40,500.

What does it really cost?

Let's work it through. Repay $40,500 over about six months of business days, and the daily payment comes to roughly $320. The $10,500 you pay for the money looks like 35 percent. But because you begin repaying the very next day, you have the full $30,000 for only a short time, and the true yearly cost works out to around 125 percent. Repay it faster, and the yearly cost climbs higher still.

Compare that with the rates you would see on most bank and credit union business loans, and the difference is enormous. Because these deals are usually written as purchases of future sales rather than loans, they often escape the interest rate limits that apply to loans.

California helps you here. State law requires most providers of business financing of $500,000 or less, including advances repaid from sales, to give you a written disclosure before you sign, showing the total cost and an estimated annual percentage rate. Ask for it, and read it slowly.

What else should I watch for?

• The daily payment in a slow week. The payment comes out whether the bays are full or empty. If sales slow again, it can drain the cash you need for parts and payroll. Some contracts adjust payments to your actual sales; others do not, or make adjusting hard. Ask how, in writing.
• Fees on top. Origination, underwriting and processing fees can be taken from the $30,000 before it reaches you.
• No savings for paying early. With a fixed repayment amount, paying early often saves you nothing.
• Personal guarantees and confessions of judgment. Some contracts make you personally liable, or include a clause that lets the funder win a court judgment against you without a trial. In 2022, the Federal Trade Commission banned one advance provider and its owner from the industry after they took more from customers' accounts than agreed, used such clauses and, at times, threatened people.
• Stacking. When one advance makes cash tight, it is tempting to take a second to cover the first. That is how a slow summer becomes a crisis.

Are there better options?

Very often, yes, though they take a little longer than tomorrow.

• Your bank or credit union. Ask about a business line of credit or a small term loan. Credit unions in particular often lend to local businesses they know.
• SBA microloans. The U.S. Small Business Administration's microloan program offers loans of up to $50,000 through nonprofit community lenders, generally at rates between 8 and 13 percent, with up to six years to repay. The average microloan is about $13,000, and the lenders often help with planning too.
• Community lenders. Many cities have community development lenders that work with small businesses banks turn away.
• Your suppliers. Ask your parts suppliers for longer terms through the slow season. A thirty-day extension costs far less than an advance.

If you truly cannot wait, borrow the smallest amount you can, and only after you have the disclosure in hand and have worked out that the daily payment fits even your slowest week.

How do I get ready for next summer?

Look back over the last few years of sales, month by month. If summer is slow every year, it is not an emergency; it is a season, and you can plan for it. In your busy months, set aside a share of every payment in a separate account, until it holds enough to carry the shop through the quiet stretch. Applying for a line of credit while business is good, before you need it, is far easier than applying in a hurry.

You have kept a repair shop running in Oakland, which takes skill and grit. Give this decision a few days, ask the hard questions, and choose the money that helps you, not the money that is fastest.

One thing to do this week

Ask the company for its written cost disclosure with the estimated annual rate, then call your bank or credit union about a line of credit.