Sometimes a business just needs cash fast. A rush of orders means restocking, equipment breaks, or something goes wrong and you have to reset. You head to Google and search “small business loans.” Within minutes you see offers ranging from $1,000 to $250,000, with money in your account in under 24 hours. A couple taps on a screen and you get the cash you need. Welcome to the world of the Merchant Cash Advance, or MCA. MCA companies operate online, and some even come embedded with point-of-sale (POS) systems like Square. MCA lenders profit from people’s desperation. And let’s face it, when you are in crunch-time, those ads for same-day funding are hard to ignore. It sounds sweet, right? Especially if you need money and have no other options. Those offers are too good to be true.
MCAs are not a loan. With an MCA, you receive cash up front in exchange for a portion of your transactions and a steep pile of fees over time. When you receive the advance via a point-of-sale (POS) system, the lender has visibility into all your sales data, and can determine the amount of the advance without even considering your business’ expenses. To the MCA, all that matters is how much you sell. So when it decides how much to lend, it has no idea what your real operating costs are. For owners, that means money that feels like a lifeline but is actually tethered to the future. Every sale you make gets shrunk by a piece the lender takes first. MCA feels like magic because it does deliver speed and easy approval. But what most owners don’t realize is that the speed comes with hidden traps. The model is set up in a way that keeps your attention on the upside, not the potential problems. Here’s the first rule of good business finance: the faster the approval and the easier the paperwork, the more you should read the fine print.
So how do you spot one before you sign? Look for language like “Same Day Funding” or “Next Day Funding” in the ad. That is the first sign. Another is that they will accept low credit scores. A low score is only one piece of a business’s financial health, of course. These companies aren’t regulated like banks or loans, which means they can offer whatever terms they want, sometimes making the repayment period even longer so they can collect more fees. So you may run into a company that has unfair policies or whose products aren’t what they say they are.
Then there’s the price. They’ll often advertise a low percentage (“We take 7-8% of every transaction”). Plenty of owners see 7 or 8 percent and don’t really take the time to think about it, “Isn’t that pretty manageable?” This is NOT a 7-8% interest rate. It is taken off the top of every transaction before you pay your expenses and taxes. It can work out to 50-90% APR if you do the math. Merchant cash advances are quoted in factor rates, not APRs. And because they’re often offered with a shorter timeframe than a traditional bank loan, the payments you’re making will be much higher than your bank payment. Even if the total you pay back looks roughly similar to a bank loan, the schedule is far more demanding, and if something goes wrong, you can’t catch up. What most owners realize when the MCA company sends over the payout schedule is that they’ve actually been charged a much, much higher fee than what was originally thought. If it sounds confusing, it’s because it is.
There may be fees you don’t know about either. Unlike banks, MCA companies have no requirement to disclose the total cost of the advance to you or the actual APR. Fees are taken out of each transaction. That makes them easy to miss, hidden in the fine print. So you need to watch out for that, too. They’re not regulated, they’re not licensed, they don’t even need a bank charter. That leaves most of the risk with you. If you ever feel concerned about a company during the application process, ask questions. If the answers don’t make sense or aren’t backed up with concrete information, don’t sign.
The confession of judgment clause is a killer. Many who run their finances by the seat of their pants will never see it in the fine print. It simply hands over your fate to the MCA provider. In plain English, confessing judgment basically means you admit liability and damages prior to missing a payment. In other words, you’ve given up your legal defense. And when you’re a little desperate, it’s a lot harder to keep your head and make a rationally sound financial choice.
What’s the Alternative?
The speed of MCA will feel good when you get the cash. But the cost and potential risk may come back to haunt you. You don’t want to be tied down and at the mercy of a predatory lender. What’s the alternative? A bank line of credit. Unfortunately, it takes a longer time to get funded by the bank. A business line of credit is safer, and it will help to build your credit. You have to apply and you won’t get the money immediately. You won’t feel the same rush of pressure, though. If you need equipment, look at the seller first. When considering equipment, many dealers offer their own financing. In this case, you should fund the equipment directly through them. No bank loan is required. Then there is investment crowdfunding. Don’t be intimidated by the fancy name. It takes longer than an MCA, too. Using crowdfunding for your business allows your customers to make small investments in the company. Some campaigns let people contribute as little as $100. When you reach your minimum funding amount, you’ll get your funds. If you already have a MCA, you can even use investment crowdfunding to refinance it. You’ll need to do a little homework before jumping into any of these options.
Run Down the List One More Time
So, before you sign, run down the list one more time.
- Did they promise “Same Day Funding” or “Next Day Funding”?
- Do they accept low credit scores?
- Are they licensed, regulated, or even a chartered bank?
- Are they transparent about the total cost or APR?
- Is there a confession of judgment in the contract?
And those fees can kill you, especially if you don’t know about them. The same questions belong in front of any program that asks you to sign or enroll. Know your options, know what’s at stake. Do your research, check the fine print, and remember, there’s a better way.
