The Downsides of Getting a Merchant Cash Advance

Posted at March 11, 2020 » By : » Categories : Business Funding,Business Services »
merchant cash advance

As a business owner, wouldn’t it be great to have access to immediate capital even if you might not have the best credit score?

There is a solution for you, called a merchant cash advance. But be advised these cash advances come with some hefty downfalls.

Any business needs working capital to be able to continue doing business, that doesn’t mean the first solution is the best idea.

In reality, these MCA’s usually end up costing more than a traditional loan. Keep reading to learn about the risks associated with them and what you should use instead.

What Is a Merchant Cash Advance?

A merchant cash advance is an advance on working capital in exchange for a percentage of future sales. These types of advances are unregulated by the government and carry a heavy risk.

Like any small business, when money gets low, you look for any solution to get back on track. And the worst part is lenders know this and may try to take advantage of struggling entrepreneurs.

Merchant cash advances are only a short term solution and usually end up costing you more money in the long run. But in some instances, it may be a last resort option.

High APR

One of the biggest downsides of a merchant cash advance is that they usually have some pretty expensive fees.

Most MCA’s are set up based on future sales and are usually paid back either daily, or monthly, depending on the rate. So the more that you make, the higher the APR gets, and can likely lead to paying back more than a traditional loan. Sometimes the interest rate gets higher than 300%.

In one business’s case, they were given an advance of almost $24,000, the payments were $500 a day, and this went on for 76 days. The total came to $37,500 in repayments. That’s about a 346% interest rate.

Typical small business loans average about 8-20% interest rates. For more information on a small business loan, check out this link.

Short Term Solution

Another major problem with merchant cash advances is that they can hurt you in the long run. They sound like a great idea when you are low on capital, but with the high-interest rates associated with them, they could end up burying you further.

It is not uncommon for people taking out MCA’s to have to take out multiple advances just to be able to pay back their previous advance, which is a very risky situation. If your cash flow doesn’t improve, you will get buried trying to pay back the ridiculously high interest.

If you don’t keep up with the payments, the issuer may sue you or your business for a breach of contract, leading you further into debt and, in some cases, bankruptcy.

MCA’s will also not help your credit, but can potentially hurt it. It may be a stipulation for the provider to check your credit, resulting in a hit on your credit score.

Unregulated

Unlike other types of loans, MCA’s are unregulated by the government leaving borrowers in a bad situation. They may be presented in a certain way to make it seem like you are benefitting, but in reality, it is the funder making out.

Many times the contract for a merchant cash advance can be confusing, leaving the borrowers vulnerable. This is what leads the merchant to high-interest rates and hidden fees.

It is not unusual for borrowers to have to refinance to keep up with the payments.

This is typically where we run into major issues.

The problem is that when you refinance a merchant cash advance the provider may use funds from your new advance to pay back your previous advance, leading to what is called “double-dipping.” When this happens, you have compounding interest, and in a sense, you are paying double interest on the loan.

This is a very dangerous situation to be in, typically ending with defaulting on the payments and having to refinance again.

Negative Cash Flow

A major problem with this cycle of taking an advance to pay a previous advance is the stress it puts on cash flow. When you are paying a couple of hundred dollars a day to the provider, that can put a strain on your cash flow, making it harder for day-to-day operations.

A majority of the time, when taking out an MCA, it is due to a need for capital at that moment. But what happens when you can’t cover your other expenses due to the amount needed to pay back to the provider? Do you take out another advance and “double-dip,” or do you default and risk bankruptcy?

This is a situation you don’t want to find yourself in, that’s why MCA’s have such a bad rep and should be used cautiously, or better yet, avoided by all means.

Alternatives to a Merchant Cash Advance

A merchant cash advance can be used when unplanned events happen and you need working capital to survive. It is recommended to only use if you have no other options.

Some alternatives to an MCA could include:

  • Short Term Small Business Loan – These loans offer an affordable alternative to MCAs. They are usually much clearer on the repayment plan than an MCA and are paid with a fixed monthly amount.
  • Small Business Line of Credit – These are very similar to a standard credit card and involve having a set maximum amount, and you pay back over time what you can afford.
  • Bank Loans – This is a great option for small businesses looking to get a loan. The problem with these is that banks have very high requirements for giving out a loan and not every small business will qualify.

In the end, merchant cash advances can help when your business has no other options. If you can keep up with the payments and pay it off in time, you can hopefully succeed with this option but it would be best if you turned to other types of funding.

If you need help with financing for your business, contact us, and we can help you make the best decision.