Merchant advances have seen a steady climb in gross fundings as the nations traditional sources of small business capital have slowed to a trickle or stopped completely. Many small business segments, especially the restaurant industry, have been utterly decimated by a lack of small business capital and credit lines.
Into this void have stepped merchant cash advance lenders that market directly to small businesses that are starved for working capital loans and may have difficult credit scenarios. Merchant cash lenders can normally work with at least some of these types of situations, and fund the loans much quicker than a traditional SBA- backed loan from a commercial bank. They collect their payments directly from the daily credit card receivables on each days sales. However, this convenience and flexibility can come at a steep price.
1.) High Rates- Merchant advance lenders typically will fund their advances at high interest rates. Any merchant cash advance lender will tell you that this is to compensate for the high risk associated with this type of capital advance. However, if the high rate has the effect of worsening a small business’s financial position over the long haul, or driving a weak business into bankruptcy, there comes a point where compensating for higher risk ends and gouging a business begins. Many times these advances may have rates as high as 50% or more for a short term loan. Because it is not regulated as true “loan” but is rather an “advance” against future credit card receivables, state usury laws governing maximum allowable interest rates usually do no apply.
2.) High Up Front Fees- Any business person who has ever gotten a call from a cash advance lender will hear about all the wonderful options available to them. What they won’t hear is the large upfront fees that can be required to apply before they ever receive the money or even a pre-approval. In the business, this is known as “getting the fish on the hook”…before you reel them in. In this way, sales associates have an incentive to get people to apply, even if they have no intention of ever approving them. Fees ranging from several hundred dollars to thousands are not uncommon.
3.) Requirement to Switch Processors- Because merchant advances collect their payments directly from a small businesses daily credit card receipts, most merchant cash advance companies require businesses to switch their credit card payment processors to ones that offer favorable terms to the cash advance lender. This means also that the advance lender is often being paid a referral fee by the processor, as well as their client. This is not only a major inconvenience for some small business, it also may be more costly on the rate being charged to the business owner.
While merchant advances have undoubtedly truly helped some businesses in need of capital, it is important to remember to ask exactly what is being offered, and the determine if it fits your businesses cost structure. Fortunately, there are new, less costly alternatives for small business loans that combine the ease and convenience of a merchant cash advance, with no difficult requirements or upfront fees.
To find out more about these options, click here.
Neal Coxworth is an entrepreneur and a 17 year veteran of the consumer credit industry with experience in originating, underwriting and processing mortgage, student and consumer credit loans. He publishes an informational blog for consumers to provide insight and analysis to all major loan types as well other topics such as credit history, that most consumers will face.