In the 1990s, a Connecticut businesswoman named Barbara Johnson found herself in a pinch: She wanted to launch a summer marketing campaign for the Gymboree Playgroup & Music franchises she operated but she didn’t have the necessary funds. Instead of giving up on the idea, Johnson got creative. She knew that parents would be bringing their kids back for classes in the fall and wondered whether she could borrow against those future revenues.
This was the genesis of merchant cash advances (MCAs), a form of small business financing that enables companies to put their future credit card receipts to use today. Today, MCAs are typically used by companies that process high volumes of credit card transactions.
According to a recent report, the market for small business MCAs that hauled in $8.6 billion in 2014 was expected to grow to $15.3 billion in 2017, with no sign of slowing down. This is not because MCAs are the “best” financial products for small businesses, though. Since the 2007–2008 financial collapse, banks have been less and less inclined to lend money to small businesses. Yet a majority of small business owners deal with cash flow challenges each year. Instead of turning to banks, these business owners were forced to look for other options. Many of them turned to MCAs because they are a quick and easy form of financing.
Does that mean they are the best option for your business? To help answer that question, let’s assess the pros and cons of this type of small business financing.
Pro #1: Fast funding
Merchant cash advances are one of the fastest forms of small business financing available. The application process is a cinch; you usually just need to submit a few months’ worth of credit card and bank statements. If you apply online and are approved, money can be in your business’ bank account in as fast as 24 to 48 hours.
Pro #2: No fixed monthly installments
Small business owners who take out MCAs repay lenders by giving them a fixed percentage of credit card receipts each month (e.g., 10%). You won’t have to worry about being unable to repay an installment in the event sales are slower than expected because lenders take a fixed percentage of your receipts no matter how high or low they are.
Pro #3: You can qualify even if you have bad credit
Securing a traditional small business loan from a bank usually requires having a near-perfect credit score. MCAs offer no such stipulations. Lenders are more interested in the future of the borrower’s business—not the past.
Pro #4: You don’t have to put up any collateral
Some small business financing options require borrowers to put up collateral (e.g., property or equipment) in order to secure funding. In the event the borrower is unable to repay the loan, the lender can recoup their costs by selling the collateral. MCAs enable small business owners to finance their operations without worrying about losing their property in the event things take a turn for the worse.
Pro #5: The amount you owe never grows
When you’re approved for a merchant cash advance, you’ll need to repay the loan plus the factor fee the lender charges. You’ll know up front precisely how much money you will need to pay back in order to settle your account. With MCAs, there’s no such thing as late fees and interest never accrues.
Con #1: One of the most expensive forms of small business financing
Merchant cash advances are quite expensive. In fact, according to one estimate, MCAs can have annual percentage rates (APRs) as high as 350%. Business owners that go this route are pursuing one of the costliest forms of financing.
Con #2: It’s a temporary solution to business problems
While MCAs can certainly help some small business owners solve temporary cash shortages, it’s not a long-term solution. How can you expect your business to get to the next level when someone’s eating into your profits every single day?
Con #3: Funds get deduction daily, hurting your cash flow
Many MCA lenders deduct funds from your credit card receipts on a daily basis. If you need small business financing because you’re experiencing cash flow problems, it doesn’t make a lot of sense to borrow from a lender that is eating into your revenue every day.
Con #4: Lenders operate in an unregulated industry
Merchant cash advance lenders operate in a largely unregulated market, which enables them to charge hefty interest fees. Some industry analysts, however, believe that it’s only a matter of time before MCAs become regulated. In any event, since they’re currently unregulated, there’s no one looking out to make sure borrowers are getting a fair deal.
Con #5: You may lose some control over your business
Some MCA providers will only lend money to businesses if they agree to operate under certain guidelines. For example, they may not allow borrowers to encourage their customers to pay in cash. They might not also allow you to close your doors for an extended period of time (e.g., take a month-long vacation) until the loan is repaid.
If your business processes a lot of credit card transactions and you need a temporary financing solution that you’re willing to pay a lot of money for, a merchant cash advance may be right for you. If, on the other hand, MCAs sound more damaging than helpful, you’re not out of options. Head over here to learn about several other forms of small business financing that are available to you.
