Let’s face it, just about every small business hits a crunch now and then where it’s coming up short on cash, and if you are just starting out or have a sketchy credit history, you’re probably not going to make it past the bank’s interview stage. The fallback is a merchant cash advance. These are easy to get, easy to use, and that’s great, but don’t let that keep you from taking a close look at the fine print.
Merchant cash advances can carry high costs. Costs and terms vary by provider. With a merchant cash advance you get a single lump sum from the provider to start. Then it gets paid back out of your credit/debit card sales over time, a set percentage of each batch.
With a merchant cash advance you can get anything from about $1,000 on up to hundreds of thousands of dollars, but whatever the total the amount you can take on will depend on your usual transaction volume. If you’ve been in business for a while and you have the payment records to show for it, you could take on more than a new business could right away. The merchant cash advance repayment period is also generally shorter than it would be for a bank loan, typically up to 18 months.
Repayment is taken directly out of your bank account by the provider. This can be every business day or once a week, and the amount is calculated based on a factor rate. This rate is based on your business credit history, but usually runs between 1 and 1.5. A lower factor rate works out to lower repayment in the end, so it pays to look into your options.
A merchant cash advance doesn’t work the same way a loan does. Instead of being charged interest, you get the cash up front, then pay a little off the top of every credit/debit card batch until it’s all paid back. That little extra on each batch is calculated by the factor rate. It’s set by the lender after it weighs your company against its own risk formula, and it’s what it will be until the deal is finished.
Working out the full repayment amount owed isn’t difficult. You just multiply the size of the merchant cash advance by its factor rate. A business that took out a $50,000 advance at a rate of 1.3 would owe $65,000 by the end.
That $65,000 cost for the $50,000 advance doesn’t sound so bad at first, but to figure out what it comes out to in APR you would have to find out how long it would take to pay it off and work out a rate from that. The average advance is paid off in eight or nine months. If you factor in the other fees the company may be charged on top of the factor, and the fact that a shorter payoff means a higher rate, the real cost climbs quickly.
An annualized-cost comparison can help explain differences from bank loans; disclosure requirements vary by state and transaction. The fact is that if you were to work out this APR you would find it’s probably costing you much more than other financing.
Easy to Get
It may be expensive, but one good thing about a merchant cash advance is that it’s easy to get. There’s no long wait and not much paperwork, and you can get the cash in hand within days of applying.
Some MCA agreements include security interests in business assets as collateral.
Some providers accept lower credit scores, but approval standards vary. A qualified financial professional can help compare available financing options. Payments may vary with sales, but fixed-debit arrangements and adjustment terms differ. That’s why cash advance companies talk about it being a more “flexible” option than the usual loan.
The drawback here is that the companies that use this the most typically have lower credit ratings, and that means they have to pay the highest rates. Firms like these can face an APR of 50% or more.
A merchant cash advance doesn’t usually include a report to any of the big credit bureaus, so even a spotless payment record won’t build up your credit score. This doesn’t matter if your credit’s in good shape already, but if your finances are shaky this is something to look at.
Taking on a cash advance can add financial pressure if your business is already struggling. Cash flow problems can lead to missing payments, which can trigger costly penalty fees, and this can turn into a downward spiral. Some try to take on more advances and that drags them deeper into debt.
These lenders aren’t held to the same rules that regulate a typical bank loan. The agreement may include obligations beyond the payment schedule. They could ask for a personal guarantee, and even if the advance itself is unsecured, they could still have the power to pursue your personal assets under the guarantee if the business fails and the funder claims a default or breach under the agreement, generally after obtaining a judgment and subject to exemptions.
A cash advance may look like quick cash, but it comes with strings. Payment is taken out of the business’ credit/debit sales, and that’s what the provider is banking on. That means it may set rules about the way you conduct business to guarantee this. Some agreements include restrictions on payment processing or changes in sales practices. You may also be stuck with a single credit card provider for the whole payoff term.
With an ordinary business loan you save money by paying it off early, but a cash advance isn’t built like that. The total paid back is generally worked out up front and stays the same no matter how long it takes, though fees and early-payoff terms vary by agreement. Paying it off early can make the APR higher.
These are short term working capital advances; suitability depends on cost, cash flow, and payment terms. If you can stay on track with the lender’s rules and repay on time you can get the money you need, but missed payments may lead to fees, collection activity, or legal action.
The contracts for these are long and complex and may make total costs harder to compare. A shaky business may sign on under pressure. If you think you’re about to sink, the last thing you should do is rush into a cash advance without understanding how it will cost you.
Being easy to get doesn’t mean it’s the best choice for your company in the long term. The right financing choice depends on your business’s costs, cash flow, and available terms.
About Delancey Street
Delancey Street is a business debt settlement company that helps business owners nationwide. Our goal is simple: negotiate proposed debt settlements with funders, subject to their agreement. We are based in New York. We tell you how it is; because your business and future is on the line.
