Three years ago, Catarah Coleman and Shoneji Robison—the “Dessert Divas” behind Southern Girl Desserts—were riding high. After several years of running the operation out of their homes and shared commercial kitchen and retail space, they were invited to open their own 1500-square foot shop in a Los Angeles mall, where they could sell their southern-inspired cakes, cupcakes, and puddings. They went on win that season’s Cupcake Wars on the Food Network, and the future looked bright.
But the Cupcake Wars were a piece of cake compared to the Borrowing Battles that were about to begin. The two women had self-funded their bakery business with savings up until then. The move to their own shop, however, brought startup costs and new expenses: payroll, baking ingredients, insurance, rent. “We started feeling the brunt of really being in business,” says Coleman (pictured above right). They needed some cushion for their working capital, but they were turned away by banks.
That’s when an acquaintance approached them and said he could get them money—and fast. All they needed to do was to prove that they had been in business for at least two years and had healthy credit card sales. The repayment would be automatically deducted from their sales receipts every day—a typical arrangement for a Merchant Cash Advance (MCA) lender, a type of online lender that specializes in short-term, high interest rate advances to businesses with good cash flow but less than stellar credit.
For more information, see our guide to online lenders.
As banks have reigned in their small business lending, MCAs have offered a lifeline to struggling businesses—but one that comes at a steep, and often inscrutable, cost. Rates are quoted in terms of multiples. For example, a $60,000 advance might cost 1.4 times the amount, or $84,000, paid back by a fixed percentage of sales or flat fee deducted on a daily or weekly basis. It’s hard to easily translate that to an APR (annual percentage rate), especially for loans of less than a year. And it’s harder still to account for hidden fees.
The women got a loan for $40,000 and quickly paid it back. It was a heady feeling. Soon, they were inundated with fast money offers. “We were like the most popular girls on the block,” says Coleman.
They took on another loan. The lender took its cut every day—before the Dessert Divas could pay a cent to employees or pay bills. “If we made $1,500 in credit card sales, we would only see maybe $300,” says Coleman. And the money that did make it to them was often delayed by days.
All of this was wreaking havoc with their cash flow, so they borrowed more money to make up for the missing revenue. Soon, they began to feel trapped in a cycle of debt. Coleman knew she had to stop. “It was like, just get me out of this and I swear I won’t do it again,” she says.
Going through the mail one day, a flyer caught her eye. She almost threw it out, thinking it was just another fast-cash solicitation. But this one was different. It was from an organization called Opportunity Fund, and it promised to help business owners trapped by high interest, short-term loans.
Coleman didn’t know it, but Opportunity Fund is California’s largest and oldest microfinance lender, a type of Community Development Financial Institution. It lends more than $2 million every month to entrepreneurs based in the state—like Coleman, many refugees from predatory loans. When Coleman called the number, she felt immediately soothed. “It was like I speaking to Jesus Himself,” she says. The voice on the other line, she recalls, said ’We can help you.’ “Those words meant a lot. Because in the past, it was always ‘We can get you this’ and then you’d never hear from them again,” she says. “It was never about helping us.”
Coleman had to fill out a form detailing, among other things, the company’s outstanding debt and the annual percentage rate they were paying on it. The last part stumped her. She pulled out her contact and didn’t see an APR listed anywhere. So she called the lender and was told she was paying 56 percent. “That’s when my month dropped,” she said. Coleman still isn’t sure whether that was an annual APR or a per transaction rate, she says, “but either way it was highway robbery!”
The Opportunity Fund offered the women a loan that would allow them to pay off their high-priced debt, totaling $57,000, with some left over for working capital. The interest rate: just 8 percent. For Coleman, it’s been like “manna from heaven.” The women get regular emails from Opportunity Fund president Eric Weaver asking how they’re doing, says Coleman. The fund also alerts the women to opportunities like grant programs and refers customers to them.
For more information on Community Development Financial Institutions (CDFIs), see our guide.
That’s a sweet ending for Southern Girl Desserts. But Coleman hopes her tale can help other business owners avoid going down the “scary dark alleys” of fast-cash lending.
“It’s important to ask the right questions. They come off as your best friend—it’s like politicians, you know, kiss the baby. They’ll tell you whatever you want to hear. So you have to ask, because they won’t offer the information unless you ask.”
Her advice? “Know what you’re getting into.” That includes knowing what your effective APR is, what your daily payment will be, and whether there are any penalties for early repayment. Also, some alternative lenders don’t report payments to a credit bureau, so your loan repayment may not help build your credit record. “We didn’t ask enough questions, but we didn’t know what to ask,” says Coleman. “Now that we know, we have no excuse to ever end up in that situation again.”
For a detailed example of MCA fees, and a calculator to help you calculate the true costs, see this pot by Fundastic: https://www.fundastic.com/posts/15-the-renewal-trap-beware-of-the-mca-refinance#.VV5U3NNVhBe
Editor’s note: MCAs are just one type of online lender. Others offer term loans expressed transparently in APRs. For a comprehensive discussion of online lending, see our educational guide. Or, check out the full range of small business capital-raising options here.