What is a Merchant Cash Advance?

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If you’re a small business owner you probably have been approached or at least have heard of a merchant cash advance. These advances are very popular in the small business community because of the quick access to capital and 48-72 hour turnaround from the advancing company. Specifically, these advances are beneficial for companies in the restaurant industry or food service industry that experience downtimes throughout the year. By having a cash advance it can help them get through slower periods. 

A merchant cash advance is a small business loan – although it is not technically considered a loan – which is given to small business owners who have poor credit ratings and need a quick advance. Typically, individuals receiving these advances require the money in order to expand, purchase new equipment, have cash on hand during a slow season, or to make a bid on certain projects. The issue with these types of business loans is the amount of interest that is expected to be paid back on the principal advancement. Another issue is how certain businesses go about collecting payments. 

Each lender of merchant cash advances operate by their own rules in terms of the interest rates that they set and how they obtain payment on those advances. That is because there is little to no oversight in the financial community for merchant cash advances, especially in Pennsylvania. According to the State of Pennsylvania’s Department of Banking and Securities, MCAs are considered as payments, not loans. Therefore, they state that no oversight is required unless they are made aware of a predatory issue. There is no federal oversight over MCAs either. 

Some states have introduced legislation to provide more transparency in merchant cash advance funding, however, if there is no federal or state oversight, lenders can take advantage of the businesses that receive the advances. This includes charging interest rates in excess of 50% and using mob-like tactics when payment is due. Taking advantage of the businesses using the advances is not a reflection of all companies that provide MCAs, but research should always be done before approaching a cash advance lender.  

Typically, lenders get their payment back by taking a portion of the borrowing company’s credit card transactions. This includes the principal on the advance as well as any interest owed – interest is generally set around 30%-40%. Depending on what organization is providing the advance, there may be a benefit to paying back the loan early, but this may vary between companies. In cases where paying off the loan early is not beneficial, interest rates on the loans will adjust for the increase and decrease in sales. Therefore, if a restaurant has a stretch of weeks where they do a considerable amount of business, the interest rate on the MCA will be higher over a shorter period of time. The opposite effect takes place when sales decline. The interest rate decreases as sales decrease and the payments get stretched out over a longer period of time. This ensures that no matter what, the institution that provided the advance is going to get every dollar back on the principal, plus the amount of interest on that loan. 

To explain this process further, consider this example. Tom owns a restaurant and applies for a $100,000 cash advance from Capital Advance Group to purchase new equipment, with a rate of 35% interest. 35% interest on a $100,000 advance is $35,000. Therefore, Tom should expect that no matter what, he will be paying back $135,000 out of his business’s credit card transactions over a period of time in order to satisfy the terms of the advance. 

These advances have become so popular that investors have taken notice. Some institutions now issue in the form of a debt security, a note for which an investor is guaranteed a certain payout over a 1-3 year period. The money that is invested is then used to provide MCAs to small businesses with the returning payments being used to pay off investors’ monthly interest. Unless those policies are insured, there is no way to protect the investor in the event of the MCA recipient defaulting on the advance. In other words, a system with no regulation, no oversight, and possibly no protection for the parties involved, can become very convoluted. 

It is important to keep in mind that whenever making an investment, there needs to be a level of accountability. While some financial groups are responsible in the way that they engage in merchant cash advances, there is a high chance that predatory loan sharks are lurking in the industry. A system with no regulation and no oversight opens the doors for many small businesses to be taken advantage of if they don’t manage their expenses wisely. The same is to be said for investors potentially investing in a product that is knowingly or unknowingly taking advantage of small businesses for their own capital gain. 

With any investment, there needs to be a degree of transparency. As long as these advances are not  regulated in some fashion to provide oversight to protect the consumer, merchant cash advances pose as more of a risky investment than a rewarding one. If a business has no other avenue to explore and desperately needs capital in order to open their doors, applying for a cash advance is their own prerogative, but on the investor side of the coin it could lead to more harm than good. 

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