Is Loan Stacking and Right For You?
There will come a time in your small business’s life cycle when you will need to borrow. Whether it is to expand, to take advantage of a new business opportunity, or to develop a new product, it is rare that existing cash flows will support making it to the next level.
Getting approval for that first business loan can seem like a huge hurdle, and when you are offered another loan shortly after taking out the first loan, it may be tempting to jump at it. Or, what if you have spent all the money from the first loan, but have not repaid it, but need more cash?
Short Term Business Loans or Merchant Cash Advance stacking has become a prevalent practice among businesses seeking additional funding. However, this strategy carries inherent risks and potential drawbacks that business owners should carefully consider. Below we explore the concept of business loan stacking, explore its process and reasons behind its adoption, examine the types of loans involved, and shed light on the legal aspects and associated risks. Additionally, we will discuss the pros and cons of loan stacking, present alternative financing options, offer strategies to avoid it, and provide real-life case studies.
Definition of Business Loan Stacking
Business Loan stacking refers to the practice of obtaining multiple loans on top of existing loans. Most of the time the stacking is in the form of short term business loans or MCAs provided by alternative lenders. It involves accessing additional funding from different sources, such as various alternative lenders, to supplement existing financial obligations. Rather than replacing existing loans, merchant loan stacking adds new loans into the mix, increasing the total debt burden.
The Process of Loan Stacking
Loan stacking entails a step-by-step process. First, a business applies for and secures some type of business funding from a lender. Subsequently, the business seeks additional funding from other lenders, effectively stacking multiple loans on top of each other. This process allows the business to access a larger pool of capital but can quickly become a complex web of financial obligations.
Reasons Businesses Resort to Loan Stacking
Businesses often resort to loan stacking due to various reasons. One primary motive is the need for immediate capital to fund operational expenses, purchase inventory, or invest in growth opportunities. Traditional loan options may have stringent eligibility criteria or extended approval times, leading businesses to seek quicker alternatives. Additionally, some businesses may already have existing business loans from a bank or other traditional outlet and then turn to stacking as a means of supplementing their current financial resources as traditional lenders do not stack.
Types of Loans that Get Stacked
Any type of loan theoretically can get stacked. Alternative lenders are generally the lender for adding positions. The subsequent stacking typically involves more business cash advances, which are short-term financing options based on future receivables. These business cash advances can be obtained from alternative lenders, fintech companies, or specialized providers.
The Concept of Subordinate, or Second Position Loans
Alternative lenders frequently take a subordinate position when lending to small businesses. A subordinate, or second position, loan is one that is second place to lay claim on your assets should you default. While traditional lenders are rarely willing to take a second place position, an alternative lender will.
If a loan is in second place, the lender gets what is left in the event of default. The first lien holder will liquidate all of the businesses assets and claim any personal assets that you may have pledged. Whatever is left is used to satisfy the second place lender’s claim.
The alternative lender will consider which bank gave you the money for the first place loan when making their lending decision. This is because they know their odds of recovering their money are better if a top-tier financial institution considered your business to be a good credit risk.
It is a riskier proposition to be in second place. To offset this risk, the subordinate lender will charge you higher fees. Subordinate loans are considered to be in a second position and have lower priority for repayment compared to primary loans. In case of default or bankruptcy, primary loans will be repaid first before any funds are allocated to subordinate loans.
First & Second Positions Further Explained
A first position business loan is simply your first borrowed dollars. The lender has a first position in case if default, that lender will be first to get paid. Second position, third position, and so on is simply your second and third MCA that you are currently paying while you are still paying the first borrowed funds. These secondary and tertiary positions are the subordinate positions. Once one is paid the next in line take that position. The main reason stacking exists because some lenders would give more to a borrower because they like the industry or the profile. So even though you may have a $40,000 advance, another lender that likes your business will give you an additional $40,000. And so on and so on.
The Legal Aspects of Loan Stacking
Yes, it is legal, but it can violate the terms of one or all of your loan contracts. Often, the first lender will have a clause in their loan that states you cannot take out another loan without their approval. Or you cannot take out any other loans, or any other loans you receive will be subordinate to their loan.
The second lender could also have clauses in their contract that states the same, at which point the two lenders would be in conflict with one another if you defaulted and they tried to seize your assets as repayment.
When lenders pull your credit report, they can see if you have any loans currently outstanding, as well as the amounts due on any lines of credit. There is often a 30-day lag between closing on a loan and when it hits our credit report. You could take out multiple loans during that time.
This is a terrible idea. Many loan contracts contain provisions that stipulate if you are in violation of certain of the loan’s clauses, you must repay the loan immediately. If this were to happen to you, it could end your business.
While loan stacking may be a tempting financial strategy, it is crucial to consider the legal aspects involved. Business owners must thoroughly review the terms and conditions of their existing loans to ensure that stacking is allowed. Violating these contractual terms can have serious legal consequences and result in breaches of agreement.
The Risks Associated with Loan Stacking
A reasonable lender makes sure that you are only borrowing amounts that you can repay. They look at your total debt service coverage ratio, a measure of your debt obligations to net operating income. Through examining financial statements, business plans, and more, they will ensure that the loan is good for both of you.
The lenders who approach you just after you have taken out a first loan, offering to lend more without an application or credit check, are doing none of this due diligence. Your risk of default rises along with the more funds you borrow, but they are gambling that not everyone will default.
Take a Loan to Pay Another
If you take out a loan because you are struggling to make payments on the first loan. It becomes a situation of robbing Peter to pay Paul when you are taking funds from one loan or line of credit to make payments on another. You would be far better off cutting costs, examining where your business plan went wrong and making adjustments. And then scale back, if needed, to get your business back on track rather than to start loan stacking.
Impact on Cash Flow
Stacking loans can have a detrimental effect on a business’s cash flow. With each loan requiring regular repayments, the cumulative amount can strain cash reserves. In cases where loan stacking is not properly managed, the burden of repayments can outweigh the available cash inflows, resulting in a negative cash flow situation. This can impede the ability to cover essential expenses, pay employees, or invest in growth initiatives, potentially jeopardizing the business’s long-term viability.
Risk of Default
As the number of loans increases, so does the risk of default. When a business is unable to meet its loan obligations, it may default on one or more loans, leading to severe consequences. Defaulting on loans can damage the business’s creditworthiness, making it challenging to secure future financing. Furthermore, lenders may resort to legal actions to recover their funds, potentially resulting in asset seizures or bankruptcy filings. The risk of default should be carefully considered before engaging in loan stacking.
Violation of Contracts and Agreements
Engaging in loan stacking may breach existing contracts and agreements. Loan agreements often have specific clauses that prohibit or restrict stacking additional loans. Violating these terms can have legal ramifications and strain relationships with lenders. In worst-case scenarios, lenders may demand immediate repayment or pursue legal action. Business owners must carefully review loan agreements and seek legal advice to ensure compliance and avoid potential violations that can lead to costly consequences.
The Pros and Cons of Merchant Cash Stacking
Like any financial strategy, merchant cash stacking or loan stacking has its advantages and disadvantages. It is important for the borrower to weigh the benefits and drawbacks and make an educated decision with this type of aggressive borrowing.
Advantages of Stacking
The primary advantage of loan stacking is the ability to access multiple funding sources quickly. Traditional loan applications may involve lengthy approval processes, and strict eligibility criteria can limit access to capital. Stacking business loans allows businesses to secure additional funding from alternative lenders or fintech companies without the same level of scrutiny. Additionally, stacking loans may offer flexible repayment terms, enabling businesses to align repayments with their cash flow cycles and potentially reduce the risk of default.
Disadvantages of Stacking
The disadvantages of loan stacking should not be overlooked. One notable drawback is the increased debt burden. With each additional loan, businesses assume more financial obligations, resulting in higher overall debt and interest costs. This can lead to a strain on cash flow and hinder the ability to invest in growth initiatives or meet essential expenses. Furthermore, the risk of default and potential legal consequences rises as the number of loans and debt obligations increase.
Alternatives to Loan Stacking
What if you are concerned about the risk of loan stacking, but still need more capital. There are a variety of avenues you can pursue.
You can try initially to negotiate for additional funds with your existing lender. If you have been on top of payments, they might be willing to raise your credit limit on a line of credit or an existing funding package. If you have already paid off a portion of a loan, ask about options to take out more funds. Your current lender will consider your request stringly as they know there are 100 lenders waiting to strike.
Another really good option is to try seeking out traditional or lower cost funding options instead. A business line of credit on top of a loan is not technically loan stacking. This is because you only make payments on a line of credit when you draw on it, and you can repay that money at any time. Once repaid, you have access to the funds again, unlike a loan where you would have to apply for another loan. There are still several other options as well.
Refinancing Merchant Cash Advances
One alternative to borrowing more is refinancing existing cash advances. By refinancing, businesses can try to receive more favorable terms and potentially more funds with the existing lender, potentially reducing the overall rate and simplifying the repayment process.
Consolidating Cash Advances
Consolidating cash advances involves obtaining a new loan to pay off existing cash advances. This strategy can streamline debt management by consolidating multiple loans into one, making it easier to track repayments and potentially reducing the overall interest costs.
In cases where businesses need capital to purchase equipment, leasing can be a viable option. Leasing allows businesses to access the necessary equipment without a significant upfront investment, preserving cash flow while enjoying the benefits of utilizing the equipment. This option is great for businesses seeking out more loans for equipment.
Private business loans, also known as peer-to-peer loans, involve borrowing from individuals or private lending platforms in one form or another. Private loans can provide businesses with flexible terms, potentially lower interest rates, and a streamlined application process compared to traditional lenders.
For businesses with outstanding invoices, invoice financing can be a practical alternative to loan stacking. With invoice financing, businesses can receive upfront cash by selling their outstanding invoices to a financing company. This allows them to access immediate working capital without taking on additional debt. Invoice financing can be particularly beneficial for businesses that experience delayed payments from customers or need to bridge cash flow gaps.
Strategies to Avoid Merchant Cash Stacking
While loan stacking may seem like a convenient solution, businesses should explore strategies to avoid its risks and drawbacks. Firstly, it is crucial to assess the actual financial needs of the business and consider alternative financing options that best align with those needs. Creating a comprehensive budget and financial plan can help identify potential funding gaps and explore more sustainable solutions.
Building strong relationships with traditional lenders, such as banks or credit unions, can also be advantageous. These institutions may offer lower interest rates, longer repayment terms, and more comprehensive financial solutions compared to alternative lenders. Developing a solid credit history and maintaining a healthy credit score can improve the chances of securing favorable loan terms.
How Financial Institutions Can Help Avoid Business Loan Stacking
Financial institutions can play a vital role in helping businesses avoid merchant cash stacking. They can provide educational resources and guidance on alternative financing options, such as term loans, lines of credit, or equipment financing. By understanding a business’s unique needs and financial situation, financial institutions can tailor their offerings to provide more suitable solutions.
Additionally, financial institutions can encourage responsible borrowing practices by conducting thorough credit assessments and ensuring borrowers have the ability to repay their loans. It is often the broker trying to ern commissions that sees a UCC filing of your first funding and then they call asking if you would like additional funding, This can be very tempting as the business is actually in need of capital. Lender management can help prevent excessive debt accumulation and reduce the likelihood of businesses resorting to loan stacking.
Case Studies of Businesses Affected by Merchant Cash Stacking
Real-life case studies serve as valuable examples of the potential consequences of merchant cash stacking. For instance, consider a small retail business that stacked multiple cash advances to finance inventory and cover operating expenses. As the debt burden grew, the business faced severe cash flow challenges and struggled to meet loan repayments. Ultimately, they defaulted on several loans, leading to damaged credit and the closure of their business.
On the other hand, another case study highlights a business that recognized the risks associated with merchant cash stacking and opted for alternative financing methods. By carefully managing their cash flow, exploring refinancing options, and building relationships with traditional lenders, they successfully avoided excessive debt accumulation and maintained a healthy financial position.
Conclusion: Is Loan Stacking Ever a Good Idea?
In conclusion, while loan stacking can provide immediate access to capital, businesses must carefully consider the risks and potential drawbacks. The impact on cash flow, increased risk of default, and violation of contracts are significant concerns that can have long-lasting consequences. As such, it is crucial for business owners to thoroughly evaluate their financial needs, explore alternative financing options, and develop a comprehensive plan to avoid the pitfalls of merchant cash stacking.
If all the risks are understood and acceptable, the key to stacking business loans effectively is to be on top of your numbers. Where is the money going, what it is being used for, and when can you repay it. Keep detailed budgets and project plans, and track spending according to plan. If the second loan is meant to support a specific business initiative, consider putting the funds in a separate account and only paying bills related to that initiative from that account.
By seeking guidance from financial institutions, building strong credit histories, and adopting responsible borrowing practices, businesses can secure financing that aligns with their needs and safeguards their long-term success. Ultimately, avoiding the lure of loan stacking and pursuing more sustainable financial strategies will contribute to the stability and growth of businesses in the ever-evolving landscape of commerce.