4 Reasons to Avoid Merchant Cash Advances

Merchant cash advances can help small businesses such as retailers and restaurants obtain funds for a variety of purposes with no collateral and without significant credit history. However, it is an industry with the potential for abuse. Watch out for the following four potential downsides before taking merchant cash advances.

Reason #1: High Effective Interest Rates

First, merchant cash advances are not loans. A merchant that has credit card sales can agree to give a portion of those sales away in exchange for cash now. The cash is advanced, not loaned. However, it looks and functions much as a loan does. You get cash now and repay it in installments over time.

The company making the advance makes money in two ways. First, there are fees to receive the advanced funds. Second, the merchant cash advance firm collects more of your receivables than the total amount of cash advanced. That difference is the profit the company makes. It is not technically interest, but it can be compared to interest.

The effective interest rates on merchant cash advances can range from 10 percent to 200 percent, but there is no limit on the interest rate. Be aware of the effective interest rate you are receiving and agree to nothing if you don’t understand and agree with the terms.

Reason #2: Self-Regulating

Lenders fall under a variety of regulations and regulatory agencies at the state and federal level. There are, in many instances, limits on what interest can be charged and there are always requirements that they disclose fully the terms of their loans.

Since merchant cash advances are not loans, they do not fall under lending regulations. Aside from self-regulation on the industry, there are no requirements they must follow and you have no place to appeal, other than going to court, if you believe you have been unfairly treated.

Reason #3: Bad Apples

There are reputable merchant cash advance firms, and the industry provides a valuable service at a fair cost to many small businesses that cannot otherwise get financing. However, because of the lack of regulation, the relative unsophistication of many small business borrowers and the immediate need that usually sends a small business owner to cash advance companies, the industry is ripe for abuse.

There are bad apples making merchant cash advances. Be certain to confirm the reputation of anyone offering merchant cash advances to you. If they cannot provide multiple references in your community in your business niche, watch out.

Reason #4: Unexpected Terms

Remember, in addition to collecting an amount of your receivables above the amount of the cash advanced to you, merchant cash advance firms charge fees for closing a deal. The best way to avoid paying unnecessarily high fees is to shop to find a reputable reasonable company.

Finally, watch out for unreasonable or unexpected terms. Is there a high minimum monthly payment? You might have a slow month and be unable to meet it and face penalties. Are you being required as a condition of getting the cash advance to change to a credit card processor the advance company dictates? If something seems unreasonable, it probably is. Again, shop for fair terms from a fair company