As underwriting tightens on traditional small business loans, more and more business owners are being forced to turn to alternative solutions for their short-term cash flow needs. Enter the merchant cash advance provider. Per Wikipedia, a merchant cash advance originally provided an upfront payment to a business in exchange for a percentage of future credit card and/or debit card transactions. The term has evolved in recent years to describe any number of small business financing options which typically provide short payment terms (usually 24 months or less) and small payments, usually on a daily versus a monthly basis.
Merchant cash advances are not considered loans, but rather a sale of a percentage of future credit card and/or debit card transactions, As such, the providers of these services do not fall under state usury laws and their regulation and enforcement. State usury laws protect consumers from predatory lending practices. This gap in regulation allows these merchant cash advance providers to operate in a marketplace with few rules to keep them in check and hold them accountable to any standard for their business practices. Given the lack of regulation, business owners would be wise to exercise caution and compare terms from several providers prior to signing away a portion of their future income.
The most common repayment method on a merchant cash advance is called a split withholding. In this arrangement, the credit card processing company will split the credit card sales between the business and the finance company per the agreed upon percentage, generally 10% up to 22%. The ACH withholding method allows the finance company to deduct its portion directly from the business’s checking account. The least preferred method is the lock box or trust bank account withholding method. This allows the finance company to deposit all of the business’s credit card and debit card sales into a bank account controlled by them. This creates a one day delay in the business receiving their portion of the proceeds.
Merchant cash advances are structured as commercial transactions, not loans. Given this structure, there is no federal regulation or oversight. The Truth in Lending Act does not come into play, either. The only regulation is at the state level, under the Uniform Commercial Code. Here are several reasons to exercise caution and thoroughly research any merchant cash advance provider prior to signing any agreement:
The typical annual borrowing cost with all fees and interest included can range from 40% well into triple digits. This depends on the lender, the size of the advance, how long it takes to repay the advance and the business’s credit card sales. This is far more expensive than a traditional bank loan with typical APRS of 10% or less.
There is no benefit to repaying early.
Contracts can be confusing.
There is a very real danger of getting into a debt cycle with no way out.
Credit reports and background checks may be required, which could negatively affect your credit score.
Merchant cash advances should be used as a last resort for business owners due to their high fees and lack of regulatory oversight. If a business owner does need a cash infusion, there are many options to consider prior to a merchant cash advance.