Merchant cash advances have been gaining popularity as a short-term business tool in recent years. Although a merchant cash advance may look like a good deal, the quick cash could really cost you. Let’s take a deeper look at what a merchant cash advance is and why you should think before you act.
What is a Merchant Cash Advance?
Merchant cash advances provide small businesses with an alternative from traditional bank loans. Business owners receive funds as a lump sum upfront from a merchant cash advance provider and repay the advance with a percentage of the business’s sales. A business owner can apply for an MCA and have funds deposited into a business checking account fairly quickly—sometimes as quickly as 24 hours after approval.
MCA providers evaluate risk and weight credit criteria differently than a banker or other lenders. They look at daily credit card receipts to determine if a business can pay back the advance in a timely manner. As a result, rates on an MCA can be much higher than other financing options so it’s critical you understand the terms you’re being offered so you can make an informed decision about whether or not an MCA makes sense to meet your needs.
How do You Repay a Merchant Cash Advance?
The way you repay cash advances varies based on the type of sales you are financing. You have a couple of options.
If you are financing credit card sales, the cash advance is paid by splitting your daily revenues with the cash advance company. The rate of payment is called the “retrieval rate,” which can range from 3% to 15% of your sales (this rate varies). In other words, 3% to 15% of your daily sales go to pay the cash advance until the debt is satisfied.
If you are financing general sales, the cash advance company gets paid by making a daily debit from your business bank account. Unlike revenue shares from credit card sales, the payment amount is fixed.
Why Do Merchant Cash Advances Seem Attractive?
If you’re a small business owner in need of capital now, a merchant cash advance may look like a good deal. You can usually get approved in a day or two- with very little paperwork. Although they are typically used as a financing option of last resort, they do have some pluses:
- Very Quick: You can often receive a cash advance within a week with no heavy documentation. Providers will spend time looking at a business’s daily credit card receipts to determine the owner’s ability to repay.
- No Physical Collateral: Merchant cash advances are unsecured, so you don’t have to supply business assets upfront to back your financing, and risk losing those assets if you can’t afford to repay. However, most MCAs do require a personal guarantee, which is a written agreement that makes you personally responsible for repaying the advance.
- Payment determined by Business Sales: Since the repayment schedule is based on a fixes percentage of your sales, repayments may adjust based on your business sales.
So, what’s the catch..why are these not the best option for a startup or small business?
Beware: The Reality of Merchant Cash Advances
MCA’s are far from a perfect borrowing option, you can get some of these advantages with other types of financing products that don’t require tremendous downsides. Let’s take a look at the reasons to be wary of merchant cash advances.
- Very, very expensive: If your business decides to use a merchant cash advance, your total annual borrowing cost with all fees and interest may skyrocket. APR typically ranges from about 40%-350% depending on the lender, size of the advance, extra fees, how long it takes to repay in full, and the strength of the business credit card sales. This is far more expensive than traditional bank loans, whose APRs are typically 10% of less.
- Increased Sales means Increased APR: For merchant cash advances repairs with a percentage of your credit card sales, the APR depends not just on the total fees paid but also on how fast you repay the loan. If your sales slow down, your payments spread out over a greater length of time and your APR drops. On the other hand, if your sales increase, you repay the MCA faster and your APR goes up.
- No Benefits to Repaying Early: Your business will get no interest savings from early repayment since you have to repay a fixed amount of fees no matter what. This differs from traditional “amortizing” small business loans, in which early repayment would result in less interest paid.
- No Federal Oversight: Since MCAs are structured as commercial transactions, not loans, the industry is not subject to federal regulation. They are instead regulated by the Uniform Commercial Code one each state, as opposed to banking laws.
- There’s a Debt-Cycle Danger: The ease and speed of MCAs can put your business into a debt cycle, especially if you don’t qualify for other types of financing. Small business owners often find themselves in need of another advance soon after taking on their first due to the extremely high costs and frequency of repayments. This ultimately leads to future cash flow problems which can really disrupt the business and put them at risk of default.
- Contracts are Confusing: The high costs and frequent repayment structure of MCAs can make them difficult to understand. Contracts from providers are often loaded with unfamiliar terms, and small business owners don’t always know what they are agreeing to before receiving the advance. MCA providers do not provide APRs, which makes it impossible to compare with other financing products. Some providers require you the receiver to sign a legal document called a confession of judgement, which forfeits your right to defend yourself in the company takes you to court.
Is There an Alternative to a Merchant Cash Advance?
The short answer is yes. Many small business owners find a short-term loan to be an alternative. And, with a strong credit profile, others are able to leverage a business line of credit to meet short-term needs for additional cash flow.
Exemplar Business Experts: Get Professional Advice Before Getting a Merchant Cash Advance
A merchant cash advance can put your business at risk if you’re not careful. We highly recommend getting real, professional advice before getting a Merchant Cash advance, or any type of business financing. Exemplar’s team of business experts can offer guidance and practical advice, today. Please email email@example.com to set up a consultation today.
You May Also Like
“You manage machines and lead people.” Impacting words spoken to a doctoral student who was loving her organizational developmental course, and grateful it wasn’t stats. I carry those words close to me as I transitioned from a doctoral candidate, to graduate, to...
Intellectual property protection is critical to fostering innovation. Intellectual property laws help protect those ideas and concepts that underpin your startup. A major part of your competitive advantage and attractiveness to investors is how well defined — and well...
In 2020, 59 million Americans considered themselves freelancers; that’s 36% of the U.S. workforce. That number is expected to surpass 90 million by 2025. This has attracted the attention of both the legal and tax systems. The difference in the legal obligations...