Business Merchant Cash Advance Dangers You Must Watch Out For

Taking an Advance on Future Credit Card Sales May Not Be the Ideal Solution

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Nowadays business owners have different areas they can run to whenever a financial crisis strikes or if there is a need to expand the business. Years back, small business owners could only run to traditional bank loans and in most recent times getting a bank loan has actually become so difficult since most banks only give loans to individuals who have impeccable credit scores.

Since the issue of personal credit scores/business credit scores was introduced, many small business owners have been missing out on traditional bank loans.

Due to this, business merchants had to come up with a new way to help small business owners obtain funding with challenged credit. The good news is with a merchant cash advance, your credit score is not a major factoring in granting you a loan.

One of the most popular funding options that merchants offer to small businesses is a merchant cash advance. This is money given to a business owner at the expense of their company's future credit card sales. After a business owner is given the funds, the lender takes control of the business' credit card sales by deducting a certain percentage of the business' daily credit sales till the whole loan is fully repaid.

Small business owners need to understand how a business cash advance works. The merchant cash advance provider determines what is called a factor rate which mostly ranges between 1.2 and 1.5. The factor rate is then multiplied by the original cash given to the borrower to get the total amount that needs to be repaid.

If you take a cash advance of $50,000 at a factor rate of 1.4, the total amount that you will have to repay is (50,000 x 1.4 = $70,000). If your daily credit sales are $2,000 and the MCA provider deducts 10% of daily sales, then you will be repaying $200 per day, meaning you will have to repay this loan in approximately one year.

Here are some things you should know about the dangers of a merchant cash advance for your business.

High Annual Percentage Rates

At times, the annual percentage rate (APR) of business cash advances runs to triple digits, something small business owners should be concerned about. The APR is the total cost of borrowing the money including all the fees and interest. Approximate APR on a merchant cash advance ranges between 70% and 350% which is way too high when compared to traditional financing. For example, bank loans have an annual percentage rate of 10% or less whereas online business loans have an APR between 7% and 108% and business credit cards have an APR between 13% and 30%.

However, the total merchant cash advance repayment amount depends on the size of the MCA, the lender, the factor rate, any extra fees and the strength of the credit card sales. As you can see, the MCAs are far much too expensive compared to other sources of funding and is not advisable and should be considered as the last option.

The More the Sales the Higher the APR

Most of the times a merchant cash advance is repaid in terms of the percentage of your daily credit card sales. This means that the repayment of the money will depend not only on the fees paid but also on how fast you repay the money.

In case your credit card sales are weak, you will have to repay the cash for a long time compared to a business owner who has very high credit card sales on a daily basis.

For example, if you get a business cash advance of about $100,000 at a factor rate of 1.3, it means you will repay $130,000 in total. If you repay $130,000 in six months, the APR would be about 60% but when you repay it in 12 months, the APR would be about 30%. This means that it is better for a business owner to spread the repayment for a longer period of time.

Repaying Early Isn't Beneficial

Another disappointing feature with business cash advance is that the factor rate is constant irrespective of whether you repay earlier or later. With normal business loans, the earlier you repay the lower the interest rate and vice versa but with a merchant cash advance, the total amount is the same regardless of how long you take to repay the loan.

Supposedly you take your own savings with an aim of clearing up the owed amount to a cash advance provider, you will just repay the same amount you would repay in a longer time period. This shows that there is no benefit with repaying a merchant cash advance early which is not ethical in terms of business. Your business cash inflow is affected just the same way regardless of how long you take to repay the cash.

Debt-Cycle Danger

Many business owners like going for a cash advance because it is easily obtainable unlike loans. However, there is always a great danger looming after you take the advance. How? Merchant cash advances are very costly in terms if interest and the frequency of repayments.

There has been cases whereby many businesses have run bankrupt since when the credit sales are very weak, the merchant cash advance provider still deducts a constant percentage of the sales. This affects the cash flow of the business. When this happens, businesses tend to look for loans from other lenders regardless of the rate they pay. This lands them into a debt cycle which gets hard to get out of.

Limitations on How You Operate Your Business

Many business cash advance lenders do have strict terms and conditions which do restrict borrowers when it comes to the operation of their business. For instance, a lender may state in their agreement that you should not discourage your customers from paying with credit cards. Also, the MCA lender might prohibit you from changing your credit card processing company until the whole debt is paid.

There are also other terms that could make it hard for you to run your business including and not limited to, no change of business' location, no room to look for another one until the MCA is wholly repaid and there should be no cash payments in your business. This will actually make it difficult for you to operate your enterprise smoothly. Thus, it is good to go through the MCA trade agreement before signing and remember after signing, the MCA provider may sue you for breach of contract. Keep these danger signs into consideration before deciding on moving forward with this funding option.