How can I tell if a business loan is really a merchant cash advance?

MCAs (merchant cash advances) are a trap that can get you into a cycle of taking on another new advance to pay off the old one. They are insidious predators of small businesses, with innocent-sounding terms to make them sound like they’re normal business loans. How do you know if someone is trying to pass off a merchant cash advance as a business loan? Unfortunately, knowing the difference between a business loan and a merchant cash advance is not always an easy matter. Seldom are they called a “merchant cash advance” in the product title, nor are they usually marketed under that name in advertising. Here are the words to be cautious of.

Here is what a merchant cash advance really is. Merchant cash advance companies “buy” a share of future receivables up front for cash, and you pay them off with a percentage of all card sales, plus a fee. It is built for quick cash, and it is very expensive.

The first reason to avoid merchant cash advances is that the effective interest rate can exceed 100 percent, and the financing fees you’re paying just to get the deal done are huge, but barely disclosed to you before you sign.

This is reason number two to never sign up for a merchant cash advance: paying early saves you nothing, the rate is flat, and regardless of whether you pay in 2 days or 30 days, it is the same cost. This one is outrageous.

Reason number three for never signing up for a merchant cash advance: Paying late or not at all can strain your relationship with your general contractor. The MCA company may call the GC over and over, and that goes bad for everyone.

The pain from a bad merchant cash advance can spill over from the business into the personal credit score, compounding the damage even further.

Another reason to stay away from merchant cash advances: the debt cycle is hard to escape. It is not uncommon for a business to end up paying off the first advance with another one, on equally bad terms.

Merchant cash advances can cut you off from the source of better business capital. Good lenders may be hesitant to deal with you if you have a merchant cash advance. And large merchant cash advance balances may disqualify you for financing altogether.

All the above is bad enough. But when it comes down to it, a merchant cash advance company doesn’t care if they ruin your company or all your workers.

The Words to Watch Out For

Nobody makes a merchant cash advance sound like it is risky. They (the MCA company) act and talk like a friend and a lender. They act and talk like they are not going to rip your head off on the financing terms. Here is a short list of the words to watch out for.

• ”Alternative funding,” because no one wants to admit they’re offering an MCA.
• ”Direct funding,” a term that pays no attention to the rate.
• ”Investing in companies,” which they say is not the same as a loan.
• ”Line of credit,” which is not the same thing at all.
• ”Bridge capital,” and they burn the bridge when you use it.
• ”Growth capital,” that won’t grow anything but their pile of cash.
• ”Acquisition financing,” a merchant cash advance by another name.
• ”Vendor payable extension,” which is another synonym for MCA.
• ”Undervalued equity,” which is another MCA company euphemism.
• ”Funding within 24 hours,” which means that the money is ready to go - right into someone’s pocket.
• ”Pledging future receivables,” which is another way a MCA can change its name.

Not every bank alternative is bad, but if you hear any of these words, proceed with caution. A company that says it is lending would be regulated like a bank, which is why they talk about “funding.” Funding is less regulated. Beware of the use of the word “investment” by a broker in sales and finance. Brokers will shamelessly hijack the term for their own advantage. If they have invested in a company or anything else, do your own research. The only returns you get are fees.

24-hour funding can happen, but it comes at a price. Predatory funding companies cut corners and skip due diligence or any stringent underwriting.

“Line of credit” looks and sounds like a bank or even a home line of credit, but it is a different animal altogether. Here’s how they differ.

First, you can’t drop to interest-only payments just because you are strapped for cash. Pay principal plus interest on cash advances at higher rates.

In second place, the rate is far higher than any reputable bank would charge.

Another difference is that a merchant cash advance is designed as a short-draw advance that typically must be repaid in full within three or four months.

Litmus Tests

Beyond the words themselves, use these litmus tests.

A merchant cash advance broker has one job: to deliver the owner of a business to the hungry shark in the water that is awaiting a MCA. Many MCA companies don’t market their services to business owners. They market their product to brokers. For example, if their website is talking to brokers, watch out. There are words that are a clue you are on a broker site. “ISO,” “syndication,” “white label,” and “bad credit,” for starters. “We take your worst deals.” “We fund bad credits.”

Some of the most crooked merchant cash advance companies hide who works there. The team page is one of the easiest pages to hide information, and one of the first that gets deleted when it reflects poorly on the leadership. Its absence on the website may be a subtle clue that something is wrong.

One of the best ways to differentiate a legitimate company from a predatory cash advance company is to check reviews, but don’t buy anything that seems overwhelmingly good. Often the reviews are written right after the owner gets funded, when the payments are not due and all is euphoria. A few months later when the company is on the brink of bankruptcy, the owner feels a little different.

Unpaid MCA fees lead to liens and court cases that are on the public record for others to see. Google the name of the lender plus suing or “court case” to see for yourself. This is one of the worst signs that you may be dealing with an unreliable lender.

If you conduct a search for “owe money to XYZ Lender?” and most of the pages are ads with a headline like “We can help,” tread lightly. Companies exist that get business owners out of specific lender’s terms.

Each lender is allowed to structure their contract differently, and often a contract may look good from the fees and rate standpoint, but then there will be a clause that makes you pay all the fees and interest for the duration even if you pay off the loan early. Make sure to check the contract for prepayment penalties, if applicable.

The proof is in the pudding they say, and the terms of payment are where a lender cannot hide the harm it is trying to do to a small business owner. The real cost is usually not shown until closing. At closing, lenders are required to disclose their merchant cash advance term in either daily or weekly payments. It is pitched to be “affordable.” For example, $10,000 a week might not seem as bad as $40,000 a month, but it drains your accounts quickly.

Accepting an offer that is higher than you can afford to repay is one of the biggest blunders a business owner can make. Merchant cash advance lenders do not care and no one will save you from overborrowing.

Typically, if you want a lower rate, you will have to pledge some collateral. Merchant cash advances don’t require any collateral, but they can still go after your assets by suing you.

When shopping for money, take a glance at the person selling it as well. The person who brings the terms can be worse than the product. High payments plus a promise to refinance you later usually means they get higher commission on you. The refinance is unlikely.

Predatory companies exist solely for the purpose of ripping off business in the middle of a cash bind. These companies do not require the barrier to entry that conventional lenders require to approve a loan, and, disturbingly, it doesn’t matter the age or size of the company. Honest, established subcontractors fall into the debt trap, too.

What You Do Instead of a Merchant Cash Advance

Anyone can talk up the issues with merchant cash advances. The real trick is what you do instead of a merchant cash advance.

Before you take a merchant cash advance, consider carefully how the payments will look one year from now. Can the business continue to operate like that? They may interfere with your operations or even halt them altogether. It is not worth the cost.

Keep your friends close and your enemies closer. Keep your banker close too. If you are dealing with a bank already, start with them before you take a MCA or any other type of advance.

The best way out is to never get in. The best plan is to build the operational and financial efficiency of the company so you never need one again. Sharpen your bidding, choose your jobs carefully and plan your financing well during the preconstruction phase.

Factor in the true cost of money, interest and financing charges on a regular basis and add them into your bids. Financing charges of all kinds will come back to haunt a subcontractor who doesn’t calculate its borrowing costs into its bids.

Contractors are vulnerable to slow-paying general contractors. You can ward it off to a degree by pushing general contractors on paying on time, and with escalation of issues at 30 days, then again at 60 days.