Introduction
Merchant cash advances are now a well-liked money option for most small enterprises when it comes to quick access to funds Unlike conventional loans which tend to take weeks of processing as well as an extended approval process merchant cash advances provide swift funds in return for part of the businesss forthcoming revenue This type of financing is well-suited for businesses with ebbs and flows in cash flow or those that don’t qualify for conventional loans because of poor credit ratings or inadequate money history Although merchant cash advances advance money instantly they also carry huge risks and economic burdens that entrepreneurs need to well comprehend before proceeding
The Basic Idea of a Merchant Cash Advance
A merchant cash advance usually referred to as MCA is not really a loan Rather it is an advance on future income usually credit card or debit card transactions advanced by a funding company to a business The provider advances the business a sum of money upfront and the payment is made in terms of a percentage of the businesss daily sales This implies that payments are deducted automatically from the businesss daily transactions until the advance and fees are completely repaid
This variable repayment scheme is one of the attractions of MCAs If there are minimal sales then repayment is also minimal and when sales are high then more is being repaid But this flexibility may be deceptive as the overall cost of the advance tends to be high and may put a tremendous burden on the cash flow of the business over time
How Merchant Cash Advances Are Structured
Merchant cash advances usually have a special structure that is different from typical loan contracts The business and the provider settle on an advance value a factor rate and a payback method The advance value is the amount of money advanced to the business whereas the factor rate typically between one point one and one point five establishes the amount to be paid back For instance if a business is advanced ten thousand dollars with a one point three factor rate it will have to pay back thirteen thousand dollars irrespective of how fast it is repaid
Repayment is made in the form of automatic daily or weekly deductions from sales usually through the business credit card processor or straight from a business bank account This method is certain to get the provider paid regularly but it also leaves the business with little flexibility in terms of its day to day cash flow
Why Businesses Use Merchant Cash Advances
Most small businesses approach merchant cash advances as an option since they are able to access money without stringent traditional lender requirements Banks and credit unions usually ask for good credit collateral and a lengthy application process which can prove to be hurdles for new companies or those in trouble MCA providers on the other hand usually do not demand good credit scores or a lot of documentation They look instead at daily sales volume and the businesss capability to generate a steady income
The quickness of funding is also a big attraction With certain MCAs companies can have money in hand within twenty four to forty eight hours of approval This fast turnaround is vital for companies with imminent expenses such as emergency repairs unforeseen inventory requirements or time critical opportunities
Furthermore, the application process is straightforward involving little paperwork Many times companies just need to offer bank statements and credit card processing reports to be in the running This efficient process makes merchant cash advances a great choice when there is little time to spare
The High Cost of Fast Capital
Although the temptation of quick money can be powerful the price of a merchant cash advance is frequently far greater than conventional financing In place of an annual percentage rate or APR the factor rate makes it hard to comprehend the real cost of borrowing When translated to an APR many MCAs have interest rates that range from fifty percent to more than three hundred percent
These exorbitant costs can easily swamp a small business particularly if the business receives several advances within a short period of time a procedure referred to as stacking The daily repayments cut down the businesss working capital for operations making it more difficult to meet basic expenses such as payroll rent and inventory Restoring cash flow becomes more and more challenging and the business can fall into a cycle of reliance on high cost advances
Effect on Business Operations and Cash Flow
Among the greatest cons of merchant cash advances is how they affect the cash flow of a business Repayments being withdrawn directly from day-to-day sales leaves each day with fewer funds to control operations Even with lean revenues days the provider remains paid its portion of a possible deficiency that keeps the business in the red when other costs come up
This strain can impact worker wages vendor pay marketing campaigns and expansion efforts Certain companies end up making financial decisions based on what they owe as opposed to overall strategy In worse cases companies end up having to take out extra financing just in order to stay afloat in addition to heightening their economic instability
Lack of Regulation and Transparency
Another significant issue with merchant cash advances is the absence of industry regulation While traditional lenders are required to adhere to federal and state lending regulations MCA providers are not held to the same standards Since MCAs are technically set up as purchases of future receivables as opposed to loans they occupy a regulatory gray area
This lack of regulation can contribute to predatory tactics like obscure terms excessive charges and hardball collection methods Some providers might hide important details in contracts or not explain clearly how the factor rate computes to repayment expenses This can cause business owners to oversimplify the cost of the advance on their finances
In addition there frequently is no ceiling on fees or interest rates which results in certain companies paying double or triple what they borrowed On a long term basis this can ruin the companys financial situation and potentially push it into bankruptcy
Legal Challenges and Enforcement
Since merchant cash advances are not viewed as traditional loans, businesses might have very few legal options if they encounter conflicts with providers Several MCA contracts contain provisions that keep businesses from contesting the agreement in court or from using arbitration within jurisdictions that are predisposed toward the provider
Some agreements even include a confession of judgment which allows the provider to obtain a legal judgment against the business without a trial This gives them the ability to seize assets freeze accounts or garnish income without prior notice These clauses place the business at a significant disadvantage and limit their ability to defend themselves legally
Alternatives to Merchant Cash Advances
Considering the high risk and possible disadvantages of merchant cash advances business owners might want to look at other financing alternatives that could be less expensive and have better terms One such alternative is a conventional small business loan from a bank or credit union While these might have more stringent requirements they typically have lower interest rates and more transparent terms
Another alternative is a business line of credit that offers flexible access to funds as needed with interest only on the amount borrowed This can be a useful tool for cash flow management and unforeseen expenses without the stress of daily repayments
Invoice factoring is another option where a company sells its outstanding invoices to a factoring firm in return for instant cash This is best for companies with slow paying clients but consistent accounts receivable It enables the company to continue operations without incurring debt
Crowdfunding and peer to peer lending are more contemporary alternatives by which businesses may raise money from investors or people through internet mediums While both avenues take work and promotion they have the potential for lower expenses and greater visibility for the business
Evaluating the True Cost and Effect
Prior to entering into a merchant cash advance contract it is important that business owners make a detailed examination of the overall cost of the advance its effect on cash flow and how it will fit into their long term financial strategy Business owners need to ask for a clear fee breakdown the factor rate and the daily repayment figures and compare these with anticipated revenue
Making sure to understand how the repayment would affect daily operations on a daily basis is critical If the company is already doing business on shoestring margins or is based on seasonal fluctuations of income an MCA may hurt more than it helps Seeking consultation with a financial advisor or accountant can be highly beneficial and determine more appropriate forms of financing solutions
Proper Use of Merchant Cash Advances
In some cases a merchant cash advance might be an acceptable option For instance a company with consistent high volume credit card sales and poor access to conventional credit could utilize an MCA to take advantage of a short term opportunity that guarantees an instant return on investment But the thing to do is make use of MCAs in a responsible manner and with complete knowledge of the risks and costs involved
It is necessary to steer clear of piling up numerous advances and ensuring repayment terms fit the businesss revenue cycles Business owners must also read all terms of the contract carefully seek clarity from the provider and steer clear of agreements with damaging clauses such as confessions of judgment
Educating Business Owners for Better Financial Decisions
Financial literacy is an important factor in assisting business owners to successfully navigate the sophisticated universe of funding vehicles Many small business owners are not formally trained in finance and thus are more susceptible to high cost funding products such as merchant cash advances Education materials workshops and financial planning resources can enable entrepreneurs to make well-informed decisions and steer clear of predatory practices
Policymakers and lenders also have a part to play in enhancing fairness and transparency in business financing Standardized terms and clear disclosures along with easily available comparison tools would help equalize the playing field and minimize the risk of businesses getting into financial traps
Conclusion
Merchant cash advances have the appeal of quick and simple capital but beneath the facade are serious financial perils that can threaten the long term viability of a company Although they might be a short term lifeline for companies in dire straits they tend to be expensive inflexible repayment arrangements and have minimal legal recourse Business owners need to approach MCAs with caution and examine all possible alternatives before coming to a conclusion Detailed financial planning expert guidance and an explicit awareness of the terms can ensure that a quick cash solution does not culminate in long term financial hardship
