Merchant Cash Advances: What You Must Know Before Jumping In

Last minute expenses that come at financially inconvenient moments don’t just happen to individuals, they happen to businesses, too. For a growing number of businesses – especially those with few if any cash reserves and maxed-out lines of credit – those surprise expenses can be disruptive to the life of the business. Think about a sudden breakdown in machinery for a small manufacturer or an industrial-size freezer on the blink for a restaurant – the cash for this type of expense is needed immediately to avoid down time and loss of revenue.

In these instances, some business owners elect to receive a Merchant Cash Advance (MCA).  This unregulated cash advance industry has attracted a fair share of unscrupulous lenders and has been the undoing of businesses as well as the lives of the business owners. Extremely high borrowing costs, hidden conditions and questionable collection tactics are common themes. In December 2018, Bloomberg published an article about the industry and the harsh collection tactics of lenders that they said are from “a bygone era.”

What attracts some business owners to MCAs is that:

• They provide immediate short-term cash needed for an expense for a business with an urgent need and no reserves to use.
• They have minimal qualification requirements and typically ask few questions about what the money is for.
• They have minimal informational requirements when applying for funds.

What should make business owners think twice – or three or four times – before signing on to an MCA is that:

• MCAs come with astronomical interest rates – as high as the triple-digits annually – and are often disguised as “factors” instead of APRs. For instance, an MCA lender lending $10,000 to a small business and charging 1.30x factor of a $3,000 fee to do so over six months implies a greater than 50% interest rate. Business owners in dire need of cash don’t often take the time to understand just how much that “factor” means in real dollars or the effective APR. It can be crippling.
• As an unregulated industry, there is little to no barrier to entry, so your MCA lender could be just about anyone. Not all MCA lenders are unscrupulous, but it definitely requires good due diligence on the borrower’s part and a full awareness of the terms of the agreement.
• The lender can deduct loan repayments directly from the borrowers’ bank accounts (sweeping the business’s checking accounts) on a weekly or even daily basis. This can result in serious cash flow problems and excessive NSF charges from the business’s commercial bank account. These NSF charges also don’t help your credit history or score.
• One MCA is often followed by another (and sometimes another); this is called “stacking”. The accumulation of debt and suffocating interest payments has caused many businesses to declare bankruptcy.
• Taking out an MCA loan often violates the terms of an existing bank line of credit. Borrowers should consult their banker to determine if this is the case. If your business is required to have an audit each year, your accounting firm will want to know this, as well; it can be an indication of financial struggles.

Of note, though the MCA industry first blossomed with restaurants that might need that freezer right away and not have cash reserves, it has expanded and affected small and medium size businesses in all industries. Calvin Blount and Tracy Eden of The Commercial Finance Group (an asset-based lender) recent told us that they have seen businesses at the $30 million revenue level taking on MCAs to meet their short-term cash needs. In 2017, the MCA industry had extended about $15 billion in credit and it is growing at a rapid rate. (Bloomberg, November 2018).

It is not unusual, nor is it shameful, to need cash and not have immediate access to it – for whatever the reason may be. There are financing options out there that present a solution with less risk for borrowers, such as factoring (“selling” your accounts receivable in exchange for cash) or asset-based lending (using your company’s assets as collateral for a loan, which you can then use to grow your business). As a business owner, you must exercise due caution when seeking capital to fund unexpected expenses and growth – even when under pressure, take the time to understand who the lender really is, what the terms of your loan or “advance” are and the ramifications of that to your business on a day to day basis, and whether it may affect any preexisting agreement with other lenders.

As accountants and advisors to our clients, we invite them to reach out to us to discuss their options and let us help them analyze their situation to determine the best solution for their funding needs. Please contact us a 404-874-6244 or fill on the contact form below.