A merchant cash advance gives a business a cash infusion fast, and for a small-business owner who can’t get a loan, the appeal is obvious. Rather than asking a business to show a good credit record or pledge collateral, a lender buys a portion of a business’s future revenue, making it a cash advance, not a loan.
You repay the advance and fees either with a set percentage of your daily or weekly credit and debit card sales, or by fixed amount automatically withdrawn from your bank account.
The more risky you are, the higher your factor rate will be. That rate shows how much you must repay for every dollar you borrow. Lenders usually offer factor rates between 1.2 and 1.5. That means for each $100,000 advanced, you’d pay back $120,000 to $150,000.
The merchant cash advance industry provides $5 to $10 billion a year. Make sure you know the downsides before you sign, though.
Several Key Advantages
A merchant cash advance offers several key advantages over a traditional bank loan or business line of credit.
Borrowing from a bank or credit union is often a long, complicated process. You will need to provide annual income records and spend time filling out paperwork. With an advance, you’ll need only a couple of months’ worth of credit and debit sales receipts or bank deposits, so getting the cash will probably take a couple of days to a week.
If you don’t repay a bank loan, the bank can seize some of your business assets as security, much like a home mortgage lender can foreclose on your home. To get an advance, you don’t need to pledge collateral.
There’s a catch: most MCA lenders want a personal guarantee from you and/or other business owners. The cash advance might not put your business at risk, but it does potentially put your personal assets in play.
A unique benefit of cash advances is that you can pay them in relation to your revenue flow, which lowers your risk. You won’t need to worry about fixed monthly payments, as in a loan, because your payments come from a percentage of debit and credit card revenue. During slower weeks when you have fewer sales, your payment automatically falls to match what the business is bringing in.
You know the full cost upfront, and don’t need to worry about interest building over time. You won’t need to worry about late fees or prepayment penalties that you might face with a bank loan. You can deduct factor fees as a business expense.
The good news for people with bad credit is that most lenders for advances don’t care about your past; they care about your likely future sales. You won’t find such a relaxed attitude about credit at a bank, which usually wants to see that a business has a good credit history. It could be a good option if a bad credit score has kept you from getting a bank loan.
Potential Drawbacks and Limitations
These advances might solve your cash flow problem, but have potential drawbacks and limitations.
The full APR here depends on how quickly you pay. If you pay off the debt early, you will still have to repay the same total amount. In fact, paying early can raise the APR. This can seem counterintuitive. You are used to the idea that paying off a loan early will lower your interest costs. In the world of cash advances, that’s not usually the case.
If your business thrives and you pay off the debt quickly, your APR will be high. But if sales are slow, then your APR falls as the advance stays with you longer. Pay quickly and you could be looking at APRs of 60% or even 100%. If you stretch it out a bit longer, it still could be 30%.
The APR with a small business bank loan would generally be around 10% or less, while business credit cards have even higher APRs, though well under 100%. The industry has no standard rates, either.
The system has little federal regulation. Because advances aren’t technically loans, there aren’t set rules. The states cover them in different ways under the Uniform Commercial Code, regulating how businesses make transactions with each other.
The effects can get complicated when businesses operate in more than one state. Besides state variations, advances aren’t governed by federal laws like the Truth in Lending Act. This lack of oversight opens the door to predatory, deceptive companies that make bad terms sound like great offers.
The language in a contract can be deceptive, making it hard to compare costs with other funding options. MCA contracts don’t usually list the annual percentage rate, the measure most lenders use to show how much they cost. It can be tough to read those contracts. Instead of saying the APR, they talk about factor rates.
Sometimes an MCA company might make you sign a contract giving up your right to fight legal challenges. That could mean you must pay, no matter what.
Some finance experts view merchant cash advances as predatory. They can act as the short term-funding of last resort, a set-up that can pull you into a deadly cycle of debt.
Some merchant cash advance companies cut into your cash flow immediately, taking a fixed dollar amount from your account daily. This heavy hand creates added risk for your business, putting some business expenses in jeopardy: payroll, rent, the light bill.
Consider the Positives and Negatives Carefully
A cash advance is not a risk-free decision, so consider the positives and negatives carefully before getting your advance.
You face a leap of faith when you take an advance. Repaying a merchant cash advance relies on your future sales. That future can look good if you handle cash flow well and business is strong, and high sales can clear the debt in months. But you also risk a heavy blow to your cash flow for a while.
About Delancey Street
Delancey Street is a premier, and award winning, business debt settlement company that helps business owners nationwide. Our goal is simple: help you escape debt in a safe and legal manner. Based out of New York, we can help in 49 of 50 states. We tell you how it is; because your business and future is on the line.
