Long lines are common at the BBQ Bus, which draws hungry Washington, D.C., locals with pulled pork, baby back ribs, bacon mashed potatoes and more. But there are times when the food truck’s lines shrink: 50% of total annual sales occur over five months, according to co-founder Che Ruddell-Tabisola.
To help cash flow in the other months, Che and his husband, Tadd, have twice turned to Square for merchant cash advances. Square, their point-of-sale system and credit card processing provider, has offered merchant cash advances to customers since 2014. Merchant cash advance providers give businesses a lump sum of cash in exchange for receiving a percentage of future credit and debit card sales until an agreed-upon amount has been paid.
It was all so simple. The couple got an email with the latest offer in February, Che says. This time around, BBQ Bus landed $15,100 in cash and agreed to give Square 18% of its future credit and debit card sales until it had paid $16,912. The advance was repaid at the end of July, according to Che.
What does that cash cost?
Opponents of merchant cash advances would point out the cost of that cash. The advance the Ruddell-Tabisolas got from Square carries an annual percentage rate of about 50%. Traditional business loans, by comparison, typically have APRs that are less than 10%.
Square’s APR, however, is on the low end compared with other merchant cash advance providers, whose APRs can range from 36% to 350%, with most businesses facing costs from 100% to 120%, according to Richard Swart, chief strategy officer at NextGen Crowdfunding. Swart conducted research on alternative financing, including merchant cash advances, as a scholar in residence at the University of California, Berkeley.
Swart says most consumers are familiar with using APR to evaluate loan costs, but the merchant cash advance industry instead focuses on total fixed costs. “It could be sticker shock if they used APR,” he says of the merchant cash advance providers.
The owners of BBQ Bus are aware of the price they paid for merchant cash advances.
“We absolutely know we’re paying more for that capital,” Che says, “but we had such disheartening experiences with different lenders.”
Scrambling for startup funds
To fund the 2010 startup costs of BBQ Bus, the Ruddell-Tabisolas approached their local bank, only to be denied. Che said they maxed out credit cards, withdrew money from retirement accounts and borrowed from friends and family to get off the ground.
Then, they tried to get a business line of credit from a bank in 2014. After days of putting together paperwork and sending documents to the bank, they were rejected.
“It’s almost like, why try when I only have so much time to do this stuff,” Che says.
With the merchant cash advance from Square, BBQ Bus received approval based on its sales history. The Ruddell-Tabisolas didn’t have to fill out an application or provide additional paperwork and collateral wasn’t required. And BBQ Bus’ payments were paid as a fee added to its credit card processing fees (Square charges 2.75% for regular swiped transactions), making the merchant cash advance feel “invisible and effortless,” Che says.
They also liked that the daily repayment fluctuated, since the amount was calculated as a percentage of sales each day. So when sales were slower in winter, BBQ Bus paid less.
“It’s been really easy,” Che says, “dangerously easy.”
Who is most at risk?
For some borrowers, the speed and ease of merchant cash advances can result in a debt trap — a cycle of continual refinancing into new merchant cash advances just to keep the lights on.
If a business is able to predict cash flow, the debt-cycle risk isn’t as high. But “if your cash flow and revenue cycle is not predictable, the daily debit can lead to problems,” Swart says.
Square, which made over $400 million in merchant cash advances to small businesses in 2015, announced in a financial report in March 2016 that it was transitioning away from cash advances and into loans, which the company says will give its customers an option that they are more familiar with.
A loan from Square, however, is similar to its merchant cash advance, with repayment based on a fixed percentage of daily credit and debit card sales. The two key differences, according to a Square representative: Loans are repaid over a maximum of 18 months, and borrowers can pay them off early.
Meanwhile, Che says BBQ Bus, which has seen its sales grow steadily as it has diversified into catering and delivery, isn’t opposed to getting a traditional loan in the future. But he expects access to capital will remain a challenge given the underwriting standards of big banks. Such institutions — those with $10 billion or more in assets — approved just 23.1% of small-business loan applications in July 2016, according to a Biz2Credit report.
The BBQ Bus may also try to work with online lenders, which charge higher APRs than banks but offer faster funding.
“We know we’re paying a premium for the capital” with a merchant cash advance, Che says, “but nobody is banging on our door to loan us money.”