There are rare times that traditional financing isn’t an option even though business is generating cash flow. You may have heard about merchant cash advance as an option. This article outlines what it is, and lays out why you should worry about turning to it.
Key Takeaways
- A merchant cash advance (MCA) provides a lump sum that you’ll finance from future cash flow, usually proven by past credit card sales.
- The repayment schedule is aggressive and can hurt near-term profits until repaid.
- Borrowing fees are called the “holdback,” and can be 50 percent to 100 percent or more.
Merchant cash advance (MCA) sounds like a helpful tool when your business has a track record of cash flow and an immediate need for funds. When you have an unforeseen expense, need to buy inventory for a critical sales season, or the chance to seize on an unexpected marketing opportunity or equipment improvement, you may be willing to trade that future revenue stream for cash now. MCAs generate quick access to capital, but come with high fees and debt drawbacks that require careful consideration. Merchant cash advance can have some severely bad consequences for businesses choosing it — and often they’re already in a bad way, or else they wouldn’t have considered MCA financing.
Why do businesses consider MCA financing? After all, banks or credit unions offer term loans at established rates. However, those loans may take too long to get the money, come with tough qualification requirements, and stringent criteria, even those backed by the Small Business Administration (SBA).
If none of these seem to work or speed is an issue, you may be tempted by MCA, a lump-sum payment based on future credit card or debit card sales. You’ll need to be able to show that you’ve got a revenue flow based on past credit card receipts and a provable future source of business income.
Businesses most likely to benefit from MCA include restaurants, retail, salons, repair shops, and small hotels. Seasonality and desperate need often create the impulse use one: a convention in town, wedding season, and tourist season can provide pressing needs with little cash on hand.
Merchant Cash Advance: Why Some Risk It
If your business has bad credit. Don’t kid yourself: Merchant cash advance is not an option for businesses sitting on cash and a beautiful balance sheet. But if you need cash and you’ve got the history to prove it, it may be the best chance to be approved for any sort of loan.
It’s all about your credit card or debit card revenue stream. The lender wants to see an established history of payments to you by credit card or debit card. Retail businesses are most likely to submit to merchant cash advance financing.
It’s fast and (maybe too) easy. Most MCA lenders often conduct their business online and make decisions as soon as they have your data. At least 90% of businesses applying for MCA financing receive some portion of their request.
It’s not a business loan. In a lot of ways it’s like borrowing money from your cousin Pat. Sure, the companies providing merchant cash advances don’t typically report your payment history to the credit bureaus. If so, then the added business liability won’t affect your score or ability to finance in other ways. But…
Merchant Cash Advance: Worrisome
MCA won’t help if you have bad credit. Because they’re not a traditional loan, but financing secured by your credit card sales, MCAs are unlikely to report to a credit bureau. This means that paying them back in a timely manner will not favorably affect the negative credit that sent you to the MCA in the first place.
The expense. Unlike the annual percentage rate (APR) of a traditional loan, what you pay back is determined by a factor rate that can be as high at 50% (or twice a credit card rate). Your total MCA cost is your factor rate plus fees such as those for origination or underwriting. This can cost too much money way too fast. In addition, the factor rate usually works out to be a larger percentage of the funding received.
They Want The Money Back Fast. MCA providers will require a “holdback,” which is the cut they’ll take of each of your credit card or debit sales until they’re repaid. (In mob movies this is called the vigorish.) They also usually want repayment in under two years. At the full factor rate, without the option of early repayment.
Fast to Seize. Most MCA contracts include a confession of judgment. You’re agreeing to forfeit your right to legal proceedings should you not pay. The MCA may only need to show the document to a court to win its judgment against you and start seizing your business assets. You may not even have the option to provide a defense — or even receive notice.
It Can Be Personal. The MCA may also require a personal guarantee, putting your personal assets (such as your house or your car) at risk in the event of a breach of contract. This judgment would certainly show up on your personal credit report.
Keeping Track. Because the holdback will be part of every transaction, you’ll need to be even more attentive to your bookkeeping. This might be a good time to align it with a document management system (DMS).
When to Move Cautiously
Merchant cash advance can sound a lot like a quick helpful solution. Maybe your business is about to turn a corner, or a supplier is offering you a great deal. More often than not, you’re your last desperate hope. Desperation can lead to poor decisions.
Danger Ahead
Just remember the danger of not being able to pay. The MCA will be entitled to take powerful collection efforts, whether through a collection agency or legal action. Legal action could mean a judgment against your business (or you personally), levies, or asset seizure. Your personal property could be seized: your personal home, and your personal savings and investments. Even if the MCA doesn’t report to a credit bureau, your credit rating can be affected when your personal finances are part of the collection effort. Your personal and professional reputation can be injured. And none of this will help if you ask the MCA to renegotiate.
MCA has worked for a very small number of businesses, but the costs and negatives of merchant cash advance are significant. As with many things that sound good, MCA may be too good to be true.
