Business Cash Advances and Business Debts: What You Need to Know
Getting financing for your small business can be tricky. Banks are notoriously stingy with small business loans, so you may be tempted by alternative lending options like merchant cash advances or business cash advances. But before you sign on the dotted line, there are a few things you should know.
What is a Business Cash Advance?
A business cash advance (BCA) is a short-term loan provided by an alternative lender, not a bank. The lender provides you with a lump sum of cash upfront in exchange for a percentage of your future credit card and debit card sales over a fixed period of time.Unlike a term loan, there’s no set repayment schedule. Instead, the lender takes a fixed percentage of your daily credit card receipts until the advance has been repaid in full, plus fees. This repayment structure allows you flexibility, but also means you could end up paying back far more than you borrowed.
-Pros of Business Cash Advances
There are a few potential benefits to a BCA:
- Fast funding. You can get approved and funded in as little as 24-48 hours since there’s minimal paperwork. This makes BCAs handy for unexpected cash flow issues.
- Flexible payments. Your repayment amount fluctuates based on your sales volume, so during slower periods you pay back less.
- Poor credit OK. Traditional lenders rely heavily on personal and business credit scores. BCA lenders focus more on your sales history.
- No collateral required. Banks require collateral like real estate or equipment to secure a loan. BCAs are unsecured, so you don’t put assets at risk.
Cons of Business Cash Advances
However, there are also some serious downsides to consider:
- Ultra-high interest rates. A BCA may have an APR north of 100%. And since there’s no fixed repayment schedule, the total interest paid can drastically exceed the amount borrowed.
- Repayment can be a huge percentage of sales. Some lenders take 20-30% of daily credit card sales toward repayment. This can sink cash flow for small businesses with tight margins.
- Prepayment penalties. Trying to pay off the balance early often incurs hefty prepayment penalties. This makes it even harder to get out of debt.
- Personal guarantee. If your business folds, you’re still on the hook for repayment. The BCA lender can (and will) pursue legal action against your personal assets.
Specific Legal Implications
Because their structure is so unusual compared to term loans, business cash advances fall into legal gray areas in many states. And regulations are still catching up.This leads to conflicts like lenders insisting they offer merchant “cash advances” not loans. This is mostly an attempt to skirt state lending and consumer protection laws.But legal experts have repeatedly stressed that “if it walks like a loan and talks like a loan, it is a loan.” Courts in several states like New York and California have officially ruled that merchant cash advances are in fact loans.This is important because it means predatory BCA companies can’t just make up rules. Like any lender, they must comply with regulations restricting misleading marketing, unreasonable terms, excessive fees, and shady collections practices.But many small business owners are unaware of their rights when signing BCA contracts. And regulating alternative finance is still a game of whack-a-mole as shady operators continue popping up.
What are the Alternatives?
If you need an infusion of working capital, business cash advances should generally be a financing option of last resort due to the staggering costs. But what are the alternatives for small business financing?
-- Short-term loans. Online lenders like Kabbage or Lendio offer more reasonably priced installment loans for funding emergencies.
- Business lines of credit. Products like BlueVine Business Line of Credit provide revolving access to capital when cash flow is tight. This avoids taking on debt all at once with a lump-sum loan.
- Invoice factoring. With invoice factoring from funders like BlueVine Factoring or Fundbox, you get immediate cash for your outstanding invoices, then pay back the funder once clients pay. This can meet short-term working capital needs.
- Equipment financing. Instead of leasing equipment long-term, financing companies like Nav offer loans tailored for your specific equipment purchases.
- SBA loans. While tougher to qualify for, SBA-backed loans through local banks let you lock in low reasonable fixed rates for longer repayment periods.
- Business credit cards. Cards like Ink Business Preferred Credit Card offer 0% intro APR periods so you can carry balances interest-free for months. Much less expensive than paying double-digit rates on a cash advance.
Tips for Avoiding Predatory Lenders
Unfortunately, predatory lending is rampant in the small business finance arena. Here are a few tips to avoid getting fleeced:
- Watch out for bait-and-switch tactics. Get all promises of low rates or reasonable repayment terms in writing first. Never take a verbal offer at face value.
- Read contracts carefully before signing. Don’t let yourself get rushed or pressured. Make sure you understand all the terms and the total cost of capital.
- Understand your rights. Research lending regulations in your state so shady operators can’t take advantage of your lack of knowledge.
- Avoid “confessions of judgement.” These clauses forfeit your right to dispute the agreement in court later. Any legit lender shouldn’t need this in contracts.
- Don’t provide blanket access to bank accounts. Lenders should only be able to pull exact owed amounts, not clean out your entire balance.
- Seek legal counsel. If something seems sketchy, or you find yourself struggling to repay, consult a lawyer immediately for guidance protecting yourself.
While a quick business cash advance may seem like an easy shortcut to solve cash woes, it often creates even bigger headaches down the road. Following these tips can help you avoid catastrophe – and financial freedom starts with healthy business financing.
In Summary
Business cash advances may seem like an easy fix for small business financing struggles. But their repayment structure makes the total interest paid drastically higher than conventional bank loans. And many alternative lenders use predatory tactics, sinking vulnerable business owners deeper into debt.Before resorting to any kind of alternative small business financing, every owner should fully understand their rights and protections in their state. And never take verbal promises or term sheets at face value – binding contracts and fine print reveal the true costs.With the right knowledge, small business owners can avoid predatory lending pitfalls. And make smart, informed financing decisions that provide working capital, without signing away the entire business in the process.