Avoid The Debt Trap for Your Business

The short-term loan can solve your immediate problem, but handicap you in the long run.

Ever wonder why some businesses offer a discount of as much as 10 percent if you pay in cash?

Here's one scenario that, unfortunately, plays out too often.

Call it "The Debt Trap.''

You own a restaurant. You need repairs, supplies, perhaps even a new air conditioning system. To gain loyal customers as a start-up, you have offered at-cost meals, but now food costs are up, you're behind on your rent and you just need to buy some time to get your feet under you.

You need cash, and you need it right away. You find a lender - an "advancer'' as some are called - that offers to float you the $50,000 immediately, taking a percentage of all credit card sales until it is repaid - plus, say $15,000 (or 30 percent). 

This is just the Get-out-of-jail card you were looking for, the way to emerge from your situation into a better one.

Or so you think. 

First, a qualification. Advances are really cousins to the high-interest credit card whose purchases they will be siphoning from. Imagine, if you will, that the advance came from the same bank which issued the card used to pay for the meal. The bank receives interest on the card's balance, and then gets a piece of the restaurant's gross revenue. 

In essence, it gets paid on the front end, and the back end.

It's like passing Go twice every time the dice is rolled. Good for them. Not so much for you.

At first, the restaurant owner barely blinks at the hefty, percentage cut of those credit card sales. After all, you've got $50,000 to pump into your business, to plug up any and all holes, You won't even feel it. 

And you don't, at the beginning, while the $50,000 is allocated. But after it's gone you are left with this cold reality: A chunk of every dollar you earn is going to your perceived  liberator, who may be getting upwards to 30 percent for fronting you that cash. In other words, for every $1,000 paid to you through credit cards, you may be receiving barely more than $700.

Get out of jail? Hardly. You are passing Go without collecting anything. 

Over and over and over again.  

Your chances of earning a profit, of expanding your business, even of hiring needed help, has been greatly reduced, along with chances of long-term survival. Hence, the 10 percent off if the customer pays in cash. It's the old end around, or so you think, potentially providing more cash at the end of the day. 

The problem of course is that you didn't pay down any of your debt. You just lived to fight another day, extending the stay in your self-made cash-flow jail. Your debt hasn't just trapped your business, it's slowly starving it as well.

The best advice always is to tend to all details before embarking on any business. But if you didn't, be wary of the offer to quick-fix your problems immediately. Because it often leaves you in worse shape than before, with no way out.