Understand The MCA Highlights
Merchant cash advance basics
This type of funding has been around since the late 90s. It’s an industry that has grown rapidly to provide easy funding to small businesses.
There is a lot of discussion around this type of financing and whether they are a good thing. Many use this type of funding because it fills a gap when nothing else is available. But before considering this option, it’s important to understand:
- What is a merchant cash advance is ?
- How they work ?
- How much do they cost ?
- What are the risks associated with this type of funding?
Understanding the merchant cash advance
A key point to understand is this type of funding is not a loan.
You are not requesting a loan, you are selling a portion of debit and credit card sales that will occur in the future.
This type of funding is very different from the term loan or line of credit, or accounts receivable financing.
This industry is not regulated.
The cash advance industry is unregulated in most states. The reason this type of funding is not protected like a loan is because you are not taking a loan but selling debt.
Courts have ruled
These advances are not loans because they are a sale of a future asset or credit card sale.
This allows the cash advance industry to avoid state usury laws that limit what lenders can charge on interest rates.
The pros and cons of merchant cash advances
Positives of an MCA
- Your business can get an immediate cash advance
- Payments are only due when you have debit/credit card sales. Contrast this with a regular term loan that requires you pay the minimum payment whether or not you have sales. The Merchant cash advance only requires payment with card sales.
- Payments remain fixed at a percentage of credit card sales.
- There are few requirements to sign up for a Merchant Cash Advance.
Negatives of an MCA
- You will pay more for the loan than what you would pay for a short term or accounts receivable loan.
- You will give up a percentage of each credit card sale, and you will pay a flat fee.
- There is a real challenge in tracking your payments and how they are affecting your balance. Because the payments change in accordance with how much your sales are, it can be difficult to understand what your payment was and how it is affecting your balance.
- You may be required to change to the MCA credit card processing system and pay higher rates on each credit card transaction, in addition to the percentage to pay back the loan. Or, the MCA will direct debit your credit card sales account, or the deposit into your business account.
- Merchant cash advances is an unregulated industry, so it is a ‘buyer beware’ kind of industry, without much in the way of consumer protections.
Who takes out a merchant cash advance?
If you were able to look at the business profiles that use cash advances you would see that the majority of these businesses have few other options. This type of financing is most often used by small retailers and restaurants that need the funds for operating expenses.
Why do they choose to use the merchant cash advance? In many of these cases they are not looking to take out large loans but short term expense type loans that will allow them to weather a downturn, a bad decision, or unexpected expenses.
Advantages of the merchant cash advance is that they often require no credit check and no collateral, so they are easy to get. This is exactly why many small businesses opt for this type of funding.
Take a breath
But the fact that they do not require a credit check and do not require collateral should cause you to stop and take a breath. If they don’t require these things that most lending institutions use to mitigate risk, then what is the offset?
Cost and shifting the risk burden to you is the answer. First, understand that MCAs are “almost entirely unregulated” because they are not supposed to be loans. They are not subject to usury laws or banking laws like the Truth in Lending Act..
The red flag should be waving vigorously for you at this point. This means that anyone offering a merchant cash advance can charge anything they want in terms of interest and fees. It has been found that some of these companies can charge 70% to 350% on the loans.
Merchant cash advances and payday loans.
There is a strong correlation between merchant cash advance funding and advance payday loans.
Payday Loans
If you’re not familiar with advance payday loans, this is a predatory business model that takes advantage of people’s short falls in weekly expense needs.
It is marketed to help people make ends meet until they get their next paycheck. In fact, it has been shown that when people use this type of funding they end up worse than before, and sometimes end up in an endless spiral of debt that is impossible to break.
The Trump administration has recently relaxed Obama era pro-consumer restrictions, making this industry unregulated just like the merchant cash advance industry.
Should you consider taking a merchant cash advance?
The answer
carefully consider all of your options.
Make sure you understand the costs, both obvious and the hidden cost of what the merchant cash advance vendor is offering. Take the time to look at any reviews that may be out there. Check with the Better Business Bureau and check with the state’s attorney office for complaints.
Review the contract with your attorney to make sure you understand how to pay off the loan, how you will track your payments, and how they affect your principal balance.
Is a SBA loan better than a merchant cash advance?
How to get out of a merchant cash advance:
Getting free of a merchant cash advance is not that easy.
First, you need to find out how much you owe the company that provided the funds. This is not that easy – remember it is not really in the funding company’s interest for you to pay off the loan.
Second, find out if your vendor charges a prepayment penalty to exit the loan early.
The best way to get out of a merchant cash advance
is pay it off. This can be done with:
- Term loan
- SBA loan
- Accounts receivable financing
- Accounts receivable factoring
- Credit line
- Increase in sales and focus the revenue to paying off the loan.
Confession of Judgement
How to get out of a merchant cash advance:
Thinking of defaulting on the loan? After all, you provided no collateral, and no credit check! Well, most merchant cash advance funders have thought of this and legally put in their contracts something called a confession of judgement.
A confession of judgment basically removes all of your rights as the borrower. If you sign this, then understand they can automatically get a judgement against you, and you may not even know it. This judgement could include their legal expenses, loss of income, and other costs. So be very careful if you are thinking about defaulting on this type of loan.
Frequently Asked Questions About Merchant Cash Advance
How do merchant cash advances work?
- A merchant proves they have sufficient credit card sales to support the advance amount The merchant completes the application
- An agreement is made on the advance amount and repayment that will be some percentage of each credit card transaction plus a one time fee up front.
- The merchant receives approval usually within 24 hours
- Cash is received
- Payments are only made when credit card sales are made
When did merchant cash advances begin?
This program was first offered in the late 90s and has grown to a multi billion dollar industry
What is merchant cash advance?
A merchant cash advance is a method where a business receives a cash advance on future credit card sales. It is repaid with each credit card transaction after the advance has been received
When should I use a merchant cash advance?
Typically when the cash needs are not for hard assets, like equipment. Merchant cash advances are used for business needs that will positively affect sales growth, but can’t be used as collateral for a loan. Marketing campaigns would be a good example.
If you are looking to fund hard assets review long term business loan
Are merchant cash advances a good idea?
In the right situations, these types of financing can have a very positive impact on the ability to manage cash and to grow sales.
Does a merchant cash advance require a credit check?
Most of the time it does not. The key to approval is longevity of the business, and strong history of credit card transactions.
Can I get a merchant cash advance with bad credit?
Usually the answer is yes if the other financials of the business support the advance
Can merchant cash advances be used for startups?
This depends on how long the company has been in business. Usually 6 months is the minimum with strong credit card sales.
Are merchant cash advances illegal in any states?
No states as of yet currently have any laws against merchant cash advances. Maryland was considering it but it has been put on hold.
What are merchant cash advance terms and conditions?
Each company is different in what they require, as this remains a basically unregulated industry. It is always wise to have legal advice when signing contracts for your business.
What is the difference between a merchant cash advance and a loan?
They are very different, summarized:
- The merchant cash advance tends to be more expensive, easier to get, and allows flexible repayment based on credit card sales.
- Loans are usually less expensive, but are harder to get and require repayment schedules that remain the same no matter the sales level. Plus, loans may require additional collateral and sometimes personal guarantees.