Are Merchant Cash Advances A Scam[yoast-breadcrumb]
Are Merchant Cash Advances a Scam?
Merchant cash advances have become an increasingly popular form of financing for small businesses in recent years. But are they really all they’re cracked up to be, or are merchant cash advances actually a scam that small business owners should avoid? In this article, we’ll take an in-depth look at how merchant cash advances work, their pros and cons, and whether they ultimately help or hurt small businesses.
What is a Merchant Cash Advance?
A merchant cash advance (MCA) is a form of financing in which a company provides a business with an upfront sum of cash in exchange for a percentage of the business’s future credit card and/or debit card sales.Here’s how it works:
- The MCA company provides the business with a lump sum of cash upfront. This can range anywhere from $5,000 to over $500,000.
- In exchange, the business agrees to pay back the advance by allowing the MCA company to take a fixed percentage of their future credit/debit card sales. This is done via automatic daily or weekly withdrawals from the business’s bank account.
- The total amount repaid is a multiple of the original advance. For example, a business may receive a $50,000 advance but end up repaying $75,000 or more over time.
- There is no set repayment schedule. Repayment happens automatically as a percentage of daily/weekly credit card sales until the full amount is repaid.
This type of financing appeals to many small business owners because:
- There are typically no strict credit requirements. Most MCA companies do not run personal credit checks.
- Funds can be obtained very quickly, sometimes in as little as 24-48 hours.
- Repayment comes directly from credit/debit card sales revenue, so if sales are down, payments are lower.
However, merchant cash advances also come with some major drawbacks, which brings us to…
The Potential Downsides and Risks
While MCAs may seem like an easy financing option on the surface, there are a number of concerns surrounding them:
Very High Interest Rates
The total repayment amount for an MCA is typically 1.2 to 2 times the original advance amount. This equates to an annual percentage rate of 60-200% or more in many cases. These rates are exorbitantly higher than most bank loans.
Daily Repayment Can Drain Accounts
The daily/weekly withdrawals from a business’s checking account can be a huge burden, especially if sales are slower than expected. Many businesses report their accounts being drained rapidly.
Lack of Transparency
MCA companies often fail to adequately explain repayment terms, total costs, and other key details upfront. Important information is buried in complex contracts.
Aggressive Collections Tactics
Some MCA providers use aggressive tactics like harassing phone calls and lawsuits when businesses fall behind on payments. They may even threaten personal assets or property liens.
Confessions of Judgement
Many MCA contracts contain “confessions of judgement” which allow the lender to obtain a judgement against the borrower without notice. This can result in assets being seized.
Potential Damage to Credit
While MCAs don’t require a personal credit check, falling behind on payments can still hurt your personal credit rating and score.
Unethical MCA companies may bait-and-switch, promising no fees then charging them, or providing less money than originally agreed upon.As you can see, the risks and downsides to merchant cash advances are plentiful. But are they truly scams?
Are MCAs Technically Legal?
The short answer is yes – merchant cash advances are legal forms of financing. However, some providers do rely on predatory, deceptive, and abusive tactics.Here are some key points on the legality of MCAs:
- Not classified as loans – MCAs are not technically considered loans by law, so they are exempt from regulations like usury caps that limit interest rates on loans.
- Loophole in lending laws – By classifying advances as purchases of future receivables rather than loans, MCA companies exploit a loophole that allows them to charge exceedingly high rates.
- Limited oversight – The MCA industry operates with little federal or state oversight compared to traditional lenders. New laws are aiming to increase regulation of the industry.
- Ability to obtain judgements – The use of confessions of judgement and personal guarantees allow companies to legally seize assets and obtain uncontested court judgements against borrowers.
- Pushing limits of law – While MCAs themselves aren’t illegal, some companies rely on false advertising, bait-and-switch tactics, and intimidation that push the boundaries of the law. Some have faced lawsuits over their conduct.
So in summary, the MCA structure itself operates in a legal gray area, but the tactics of some providers stray into illegal territory.
Warning Signs of an MCA Scam
While MCAs as a whole aren’t definitively scams, certain providers use particularly predatory and manipulative tactics. Here are some red flags to watch out for:
- Requiring upfront fees before providing the advance
- Advertising “no fees” then charging origination/documentation fees
- Refusing to provide detailed rate and repayment information until after signing
- Pressuring you to sign quickly without reviewing the contract
- Misrepresenting qualifications, such as saying “no credit check required” then running credit checks
- Lying about repayment terms or withdrawal amounts
- Harassing communications and threats if you fall behind
- Requiring a personal guarantee or confession of judgement
- Having no license on record with state regulators
If an MCA company exhibits one or more of these warning signs, its best to avoid them entirely.
Tips for Avoiding MCA Scams
If you do decide to pursue a merchant cash advance, here are some tips to avoid becoming the victim of a scam:
- Shop around – Contact multiple providers and compare offers in detail. Get quotes in writing.
- Read contracts thoroughly – Don’t sign anything until you’ve reviewed the full contract and understand all terms, rates, fees, etc.
- Research lenders – Check state licensing records. Search online for reviews and complaints. Beware of “copycat” names mimicking reputable companies.
- Avoid personal guarantees/COJs – Refuse any contract that requires your personal guarantee or a confession of judgement.
- Start small – Don’t take a huge advance right away. Start with a smaller amount to test out the provider.
- Maintain communication – Keep your provider updated on any changes in your business that may impact repayment. Seek reconciliation if needed.
- Know your rights – Understand laws that protect small businesses so you can report predatory lending practices.
The Bottom Line
At the end of the day, merchant cash advances are risky products that can end up doing more harm than good for small businesses if not used carefully. While not all MCA companies are scammers, the lack of transparency and regulation in the industry leaves the door open for many predatory providers.Businesses should consider safer financing options first, like SBA loans, business credit cards, or business lines of credit. But if you do pursue an MCA, adhere to the tips above to minimize your risk and avoid becoming the victim of a scam. With caution, an MCA may be able to provide short-term access to capital during challenging circumstances.