Merchant Cash Advance: The Pros and Cons for Small Businesses

As any small business owner knows, nothing is ever for certain. Sales can be up one month, and down the next, with no predictable trends to be found. Sometimes you need a little extra money to make payroll or purchase equipment for an expansion, and a traditional bank won’t approve you for a loan. 

That’s where merchant cash advances come in. Providers rarely look too deeply into your credit and approval is lightning-fast when compared to your average bank. But are they the right option for your small business?  

What is a Merchant Cash Advance?

Businesses with temporary cash flow issues sometimes look to merchant cash advance providers to tide them over until sales increase. Merchant cash advances are a popular option for businesses with a large proportion of sales paid for with credit and debit cards. These advances aren’t loans per se, in that they lack some of the things you’d normally find in a traditional bank loan. Things like collateral, repayment schedule, and creditworthiness paperwork. 

Instead, the provider examines credit and debit card sales records to determine how much money they can safely provide to a business. From there, the provider usually takes a percentage of the business’s credit and debit card sales to repay the balance –– often on a weekly, or sometimes daily basis. Businesses can also opt to have a fixed amount of their sales automatically paid to the provider on a similar schedule.

How To Get a Small Business Merchant Cash Advance

Suppose you need an extra $100,000 to pay your employees, purchase inventory, and keep the lights on at your business. To receive an advance, a merchant cash advance provider will request your credit and debit card receipts for the past several months to learn more about your current sales volume. They’ll then assign you a factor rating, which is your interest rate. 

A factor rate of 1.5 means you’ll need to pay back $150,000 on your $100,000 loan. It’s not expressed as an annual percentage rate (APR) because the repayment period is flexible and is usually based on your sales volume. Longer repayment periods have a lower APR than shorter ones as the provider receives the same fee either way. From there, you can decide whether you’d like to pay the provider a percentage of your daily/weekly sales or a set amount for the same period. 

Should You Use Merchant Cash Advances?

As with any type of financial product, merchant cash advances have their upsides and downsides, and only you can decide what’s best for your small business.

Pros

Quick Turnaround Time

Loan applications can take weeks to process –– time you don’t have as a small business owner. Merchant cash advances don’t require as much paperwork and you can usually get your money in under a week.

Repayment is Based on Sales

If you take out a loan, you need to pay back a fixed amount every month, even if sales are down. Merchant cash advances are repaid as a percentage of sales, so you don’t need to worry so much about defaulting.

You Won’t Lose Your Business 

No physical collateral is required to receive a merchant cash advance. These are unsecured loans and repayment is a percentage of sales. With a standard business loan, the assets of the business are used as collateral and you could lose them if you default on the loan. That’s not to say you can walk away from the loan though; many providers require you to sign a personal guarantee whereby you agree to pay back the loan. If you don’t make any efforts to do so, they can still come after your assets.

Cons

High-Interest Rates

The worst aspect of merchant cash advances is their sky-high interest rates. Many have an APR that’s over 100%, making them closer to a payday loan than a traditional bank loan. APR varies based on the expected repayment period with longer periods having much higher APRs. 

Can Harm Your Credit Score

Merchant cash advance providers will sometimes, though not always, do a hard credit check in addition to a background check. If they pull your credit report, your score is going to drop five to ten points. This is not great if you already have bad credit.

Regulation is Lax

Merchant cash advances are considered business transactions instead of loans, which allows them to skirt federal regulations like the Truth in Lending Act. You’ll need to read the fine print to ensure you’re getting a fair deal.

You Can’t Repay Early

This is not entirely true; if you want to repay early you can, but there’s no benefit to doing so. The fees on a cash advance are the same whether you pay it off in one month or six months. If you pay it off early, the interest rate rises, and it goes down if you take longer to repay. The fees are the same either way. 

Merchant Cash Advance Alternatives

Merchant cash advances can be a valuable financial product for businesses struggling to pay employees or purchase critical assets, but their downsides are numerous –– particularly the higher APR found on most advances. A good alternative to these advances is online lenders, who can approve loans much faster than traditional banks while having only somewhat higher interest rates, and much more flexible repayment terms. 

LendThrive offers fixed rate business loans from anywhere between $25,000 and $150,000. There’s no penalty for early repayment on your loan, so you can pay it back and additional interest charges as soon as business picks up. Get approved in as little as 24 hours!

Contact LendThrive to find out how your small business could benefit from one of our fixed-rate loans, or apply now to bring your cash flow problems to a quick and trouble-free resolution