Thinking about going with a quick payday-style loan? These can be easy to get, but they come with high, expensive risks for small businesses. Here’s what to know, and where else to turn for more stable credit.
Consumer payday loans are a notoriously fast, easy option for individuals who are desperate for cash. The money isn’t hard to get, but the cost of borrowing is very, very high. Payday loans are typically capped at $500, or $1,000 in some states. In Oregon, however, payday lending is legal up to $50,000.
Unlike consumer payday loans, there is not actually a payday loan for business owners. The nickname applies to a couple of expensive, short-term financing options: merchant cash advances (MCAs) and ACH loans. These are marketed to businesses rather than consumers. These have some common characteristics with consumer payday loans but are not the same.
For any business owner, the lure of quick, accessible cash is a powerful draw. But taking a business payday loan is a dangerous move. Just like their consumer equivalents, MCAs and ACH loans can come with extremely high interest rates.
How high are we talking here? The interest rates on payday loans average 391%. Merchant cash advances can go as high as a 350% APR. According to Nav.com, ACH loans can carry an annual percentage rate, or APR, of 200% or more.
Both merchant cash advances and ACH loans are a slippery slope into debt. You’ll be tempted to take out a new advance to pay off the last one. If you get one, you can end up in what’s called a debt spiral: forever borrowing new cash to pay old debts. It’s really hard to get out. Fees will start to stack up. Worse, these advances will quickly suck up your cash flow, which could put you out of business.
A Merchant Cash Advance and an ACH Loan
These two types of credit have a few common points. But they’re not the same thing and it’s important to know the differences. What exactly are a merchant cash advance and an ACH loan?
A merchant cash advance is a specific type of business financing. It’s meant to help small business owners access short-term cash.
A cash advance is where a business essentially sells future credit card sales in exchange for cash now. The appeal of a merchant cash advance is in its speed. In some cases, approval comes within 24 hours. No collateral is required, either. The provider gets a holdback: a certain percentage of every credit card sale, every business day or week, until the advance plus fees are repaid. But this quick access to cash comes with a price.
Merchant cash advances are quick and easy, yes, but they can be very risky, expensive and predatory. Hence the payday nickname. Those very large daily or weekly payments push many owners to take another cash advance to stay in business. Not surprisingly, as a result, many are looking for an MCA exit strategy.
ACH loans are much like MCAs: short-term, high-cost financing. But there are three key differences.
- First of all, the funds are based on all of your future sales, not just those made on a card.
- Unlike an MCA, payments are automatically pulled from the business bank account, not from a credit card processor.
- Third, they come with a fixed rate rather than a holdback.
The short term and steep price tag of an ACH loan can actually push businesses to take more loans, compounding the debt. With an ACH loan, as with a merchant cash advance, the lender sets repayment terms and sticks to them. It also won’t save you any money to pay the loan off early.
Other Financing Options
Obviously, none of the options above are very appealing. So, what other financing options might be available for your small business? If your business is desperate for money, it makes more sense to find a better alternative.
Invoice factoring is a way of financing small and medium businesses from unpaid invoices. You sell your unpaid invoices to a factoring company, who gives you 80 to 90% of what the invoices are worth right away. The factor then collects, and pays you the rest minus a small fee.
It’s easier to get approved for than a bank line of credit. That’s because a factor looks more at the credit history of the business’s customers, not so much the company’s own history. This means that even if your business has poor credit, or little or none at all, factoring may still work.
- Businesses with expenses in between invoices.
- Owners who have poor credit or who may have credit challenges.
- Businesses that want help with collections.
With invoice financing, your business borrows from a lender against unpaid invoices as collateral. It’s also called invoice discounting. Like factoring, it involves the invoices. Unlike factoring, though, you’re not selling them. You get the cash, keep doing the work, and collect the payments. Your customers needn’t know what’s going on, which is a bonus.
- Businesses that want to keep collections in-house.
- Business owners who would prefer their customers not know they’re being financed.
- Businesses who want slightly cheaper funding than factoring.
Another option is a business credit card. Your company can use one of these just like a personal card, for expenses up to a certain amount.But many require at least average credit. If you’re a new business owner, or someone with low or no credit, this can be an uphill battle. Secured business cards are an option for those with little or poor credit, but they do need a cash deposit. Secured cards can be useful to build up credit over time. But the actual deposit could put a strain on the business’s cash flow.
- Established businesses with a track record of on-time payments and debt management.
- Businesses who have a number of expenses they prefer to pay for with a card. And the points system could be a way to earn rewards.
- Owners who want to build credit history, even with a secured card.
Microloans are another option. These small amounts are meant to help start or grow a business. Loan amounts and usage can vary by lender, but $50,000 is usually the most you can borrow. For instance, the Small Business Administration (SBA) offers microloans which, among other rules, can’t be used to buy real estate or pay off existing debt.
- Small business owners who have difficulty qualifying for a regular loan.
- Owners who only need a small loan amount.
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.
