As interest rates rise, access to capital is increasingly restricted for the small businesses that make up the core of the American economy. However, some far-left lawmakers and activists want to restrict access even further under the guise of protecting consumers.
Rising interest rates mean that the rate at which banks can lend reserve balances to other banks is rising, increasing the costs for small businesses to receive traditional loans from banks. As costs exponentially increase, consumers will have even less cash due to paying off inevitably higher interest rates on credit cards.
During the summer, many economists warned that rising interest rates would restrict capital to small businesses over time. Rohit Arora explained in Forbes on June 20, 2018 that small businesses should apply early for loans because capital will be restricted to them over time as a result of rising interest rates.
“Companies that need to borrow money for growth incur a higher cost of capital when interest rates go up. This includes firms that have already borrowed money since most small business loans come with floating, rather than fixed, rates,” Mr. Arora wrote.
While interest rate hikes will have a negligible impact on larger companies seeking access to capital, smaller companies will find slim opportunities for access to cash. In response to this growing crisis of capital, a highly specialized form of financing company has emerged, dubbed the merchant cash advance (MCA) business model.
The merchant cash advance model is an alternative form of financing, rather than a traditional loan. Companies in need of a quick influx of capital receive cash from a MCA company in exchange for a portion of future sales or profits. Since the MCA model doesn’t constitute a traditional loan, it is not subjected to regulations on annual percentage rates of interest.
These cash advances range from $5,000 to $500,000 and have advantages over the route of acquiring a traditional loan. For example, seasonal businesses that operate for many months without a cash flow can easily acquire sorely needed capital utilizing the MCA model.
These financial instruments have become the preferred method of acquiring capital to pay expenses for many small businesses who are not excited about long waits for approval and having to put up personal property, like a home, as collateral for a small business loan.
In response to California state legislation attacking the MCA model, the Commercial Finance Coalition (CFC), an organization seeking to standardize the MCA industry, wrote a letter opposing “undue hardship upon small business” by “removing their freedom of choice in the financial marketplace.” The California example is being considered by other states as a way to crack down on a handful of bad actors in the industry in a way that will sideline all the other ethical companies who use this model of financing small businesses in a way that both benefits small business as a whole and the providers of this financial instrument.
“Small businesses need funding to maintain and expand their operations and CFC member companies offer fair and innovative marketplace alternatives to typical term loans and have filled the void created by the decline in small business lending by larger, traditional banks. The continuation of this bill will not only hurt our business, but will hurt the countless small and medium sized businesses across the state,” the letter continues.
Small businesses remain the backbone of the U.S. economy. According to a Small Business Administration 2015 report, 99.9 percent of U.S. employer firms are small businesses that employ 47.5 percent of private sector employees. When companies have no alternative, an MCA agreement can mean the difference when it comes to staying in business, and it’s important that the federal government respect free markets by preserving small business owners’ freedom of financial choice.
When critics on the left decry the high interest rates associated with MCA agreements and call for regulation, they not only misunderstand the industry entirely, but deny the free agency of millions of small business owners across the country.
MCA agreements fill a need at a time when only 25 percent of small business loan applications are accepted by big banks, small businesses remain desperate for funding. Interference by a overbearing government would not only endanger this burgeoning industries’ financial future, but that of the thousands of small businesses and workers that are dependent upon it.