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 financing, 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.
With loans, you’ll agree to an interest rate. With MCAs, you will instead be charged according to a factor rate – which, on average, ranges between 1.2 and 1.5, based on your qualifications. 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 two 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. The cost of capital, 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 Cost of Capital Can Be High
Merchant cash advances have tended to be a last resort option for cash-strapped businesses in the past. However, they are growing in popularity these days, especially among business owners that struggle to secure financing from traditional lenders.
MCA funders have more flexibility than a lender on a bank loan typically has, but this added flexibility can sometimes come with a price: if the business’s qualifications are not pristine, the funder might charge expensive factor rates. In fact, when all is said and done, if you’re paying one of the high factor rates that less reputable funding companies are known for– and you make a payment daily, and your sales are great – the effective interest rates can reach into the triple digits. Businesses should be of this when choosing a funding company to work with, as it can drastically change the cost-effectiveness of the capital they are receiving.
Additionally, with a merchant cash advance, there is usually no benefit to paying off your balance early. Unlike with many 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 amount owed.
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 same stringent federal regulations that loans are. This decreases both your protections and the requirements placed on providers by regulators. If you have ended up working with a company that is not following best practices as a funding provider, allowing them to be you may find that they are much less upfront than other financing sources.
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 financing companies pressure you with tactics of relentlessness and vague promises. As with any type of financing, 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. When you get financing that works whether via an MCA or otherwise, your business can not just survive; it can thrive.