It’s no secret that merchant cash advance companies have developed pretty bad reputations. Reputations for sketchy agreements that unrelenting scammers force upon inexperienced business owners.
These assessments aren’t that far from wrong. The industry is famous for persistent advertising, relentless cold calls, and the pressure to make rushed commitments. While there are some legitimate services out there, they come with strings attached.
In this article, we’ll provide a look at what exactly a merchant cash advance is, the potential benefits to and risks of this kind of loan, and the negative aspects and tactics your business should be wary of.
1. How do Merchant Cash Advances Work?
Merchant cash advances are relatively straightforward in premise: A company provides a business with an upfront sum of cash, and then in exchange, that business provides them with a portion of their future sales. However, once you start looking at terms, merchant cash advances can become more confusing.
Merchant cash advances are different from loans. When you take out a business loan, you will have a set time frame to repay the loan, and will be required to make monthly fixed payments. When you get a merchant cash advance, you’ll make monthly, weekly, or even daily payments out of your earnings, until the advance is paid in full.
As for the fees associated with them, you’ll agree to an interest rate – with MCAs, referred to as a factor rate – which, on average, ranges between 1.2 and 1.5, based on your credentials. As an example, if you take a merchant cash advance of $100,000 with a factor rate of 1.5, you’ll have to repay $100,000 x 1.5 = $150,000.
The 2 means of reimbursing a merchant cash advance are through the provide either: 1) taking a regular percentage of your credit and debit card sales, or 2) taking fixed withdrawals based upon your expected earnings.
2. Merchant Cash Advances are Quick
Merchant cash advances are much faster than other business funding routes. In fact, they can many times be acquired in less than a week’s time, making them beneficial for businesses that are in desperate need of capital. When assessing a business to decide whether they want to issue a loan, merchant cash advance companies typically look at daily credit card receipts or daily operational receipts to determine whether or not a business will be able to repay the advance.
3. Merchant Cash Advances are Unsecured
A benefit of merchant cash advances is that sometimes you don’t have to worry about losing your personal assets if you fail to repay the advance. Many merchant cash advances don’t require you to put up collateral (such as your home or car). But this comes with a catch. Interest rates, as we’ll discuss below, can be outrageous.
But, there are other ways providers can secure them that can still put your assets at risk; for example, you could be required to sign a personal guarantee. You should always carefully look over any agreements before signing them.
4. They Can Be Tied to Your Sales
As noted above, merchant cash advances can be tied to your monthly credit card sales; in these cases, the lender takes a percentage of your income each day, week, or month. This can be beneficial if your sales start to stall, since your payments won’t be monthly fixed amounts, as they would be with a typical loan.
5. The Effective Interest Rates Can Be Exorbitant
Merchant cash advances tend to be a last resort option for cash-strapped businesses. Providers are not extremely worried about credentials on account of the often extremely expensive interest rates they charge. In fact, when all is said and done, if you’re paying 1.15 factor rate every time you make a payment – and you make a payment daily, and your sales are great – the effective interest rates can reach into the triple digits. Businesses should be extra wary of this, especially because there are so many loan options available that can provide working capital at much lower rates.
Additionally, with a merchant cash advance, there is no benefit to paying off your debt early. Unlike with many other loans with which you can save interest by paying early, the factoring amount you agree to is the amount you’ll pay, regardless of when you decide to pay off the debt.
6. Merchant Cash Advances are Relatively Unregulated
As much as they may sound like loans, merchant cash advances are not legally classified as loans. As such, they are not subject to the stringent federal regulations that loans are. This decreases both your protections and the requirements placed on providers, allowing them to be much less upfront than other loan institutions.
7. There Are Many Alternatives These Days
Speed of funding has been the biggest advantage to merchant cash advances in the past. Nowadays, however, there are all kinds of online lenders that are reputable, dependable, and, most importantly, fast. You can file online and get funded in a matter of days.
Alternatives today for securing capital and shoring up cash flow include lines of credit and invoice factoring. Additionally, if you are suffering from a poor credit rating and instability, there are many alternative lenders offering loans that are suitable for your businesses’ needs. Types of small business loans you could consider include microloans, which are offered through the Small Business Administration (SBA) for sums usually not exceeding $50,000.
This is not to say that all merchant cash advances are bad, as there are legitimate sources out there, but you shouldn’t let any lenders pressure you with tactics of relentlessness and vague promises. As with any type of lending, it is crucial that you give due diligence to any contract or agreement you are considering.
Today’s market offers multiple opportunities for borrowing, and your business can benefit from choosing the right one. That might be a merchant cash advance, and it might not. Understand your business’s needs, learn your options, and do your research. Make sure you’re not signing a contract that will just keep you in never ending debt. When you get the loan that fits, your business can not just survive; it can thrive.