• Working Capital or Permanent Capital?

    There was a recent post on the Daily Funder titled “Length of Deals is getting CRAZY!” As a grizzled vet of the industry, I thought it would be helpful to offer a perspective on longer term deals.

    In a past life I was CEO of a large commercial construction company. We had a working capital line from our bank of $2 million secured by our accounts receivable. The term of our credit line was one year; every year we were required to submit audited financial statements within 120 days of our year end and the bank would renew our line. But the bank had the option not to renew our line if they were not satisfied with our financial performance and call any outstanding balance on the line at that time. The bank was providing working capital, not permanent capital.

    We would typically draw on the line 2-3 times per year - when we had significant start-up expenses for a few large jobs; when we had to pay taxes; or if we bought a large piece of equipment. I would always try to pay the draw back in 3-4 months.

    Sounds like a 4 month working capital loan, right? Isn’t that the point of a 6 month MCA – to meet a current need and have the merchant be able to draw again in 4-6 months for the next capital need? That is the problem with the 15 – 24 month deals that are being offered to merchants today. Our industry is based on providing working capital to merchants. By its very definition, working capital is less than 12 months. Longer term deals are permanent capital, even when they are repaid over 15-24 months.

    For the merchant, taking one of these longer term deals means they cannot access working capital for a long time, unless they choose to stack with other funders. And if they stack, they will go on someone’s blacklist/do not renew list. While the larger amount and/or lower daily repayment of a 15-24 month deal might be appealing to the merchant, the longer term deal is not in their best interest unless they are unusually disciplined and won’t need working capital until they are 50% paid off on the longer term deal, which generally will be about 12 months. So the merchant must genuinely understand that they are taking permanent capital, not working capital.

    What about the funding companies offering these deals? It’s not about who has the capital to be able to afford to make these offers; our industry is awash in capital these days. A bit of historical perspective is helpful to understand the problem that these longer term deals could present for the funding companies. Back in September 2008 when the finance world crashed there were no 12 month+ deals. All deals were 6-8 months. But it was no surprise when the economy tanked in late 2008 that the merchants in our portfolios at that time took a major hit to sales and therefore the funding companies losses increased by 50% or more on their outstanding portfolios. So what happens when the next recession – big or small – hits and funders have portfolios out to 24 months? It doesn’t take an MBA from Harvard to figure out that answer.

    Our industry continues to receive institutional capital from banks and equity investors. Unfortunately, that has led to some bad business practices as funders look to deploy capital. New products and new innovations are great and we have seen some really interesting product developments in the past 12 months. Unfortunately, I think deals over 12 months are bad for the merchants and bad for the funders.

    By: Jeremy Brown
    https://www.rapidadvance.com


    Publisher: DailyFunder
    Comments 5 Comments
    1. Capital Stack's Avatar
      Capital Stack -
      This is a great post! Thank you Jeremy, for contributing to our community.

      Like up-top our integration with Facebook will put this on your FB page
    1. sean cash's Avatar
      sean cash -
      I remember the 2008 blow-ups in MCA. Longer and longer term programs seem like a genius idea...that is until they don't.
    1. Finance1's Avatar
      Finance1 -
      Excellent article. Businesses are notorious for needing more money before renewal time. And this applies to 6-12 month deals. The longer terms have the potential to hand tie businesses owners and put them in a position they wish they hadn't gotten into. Time will tell.
    1. CO1's Avatar
      CO1 -
      This article just proves my point! We should call these deals as the 1% !
    1. Worldwide Capital's Avatar
      Worldwide Capital -
      Some great Points there. I don't mind a LOC product with longer term, But Cash advance upto 24 months just puts merchant, Funder and Broker into a situation. I funded a deal yesterday wanted to syndicate but didn't wanted my money to be stuck for 18 months, Merchant is in Wholesale business for sure he will be back in 5 months for more money, What am I going to do stack on my on deal? let merchant get stacked by other broker and loose my commission and renewal ? tough situation for everyone. I try to work on deal no more than a year or simply take them to term loan program.

      Great Article!
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