Beware: Merchant Cash Advances


Are you a proprietor of a small business with cash flow challenges? Have you received advertisements about merchant cash advances in the mail and are considering the offer? Before making a decision, you should be aware of the costs and other alternatives like business debt consolidation.

It is a known fact that starting and operating a small business can be a risky proposition. With sales being highly variable and costs fluctuating, a predictable and stable balance sheet is rare. So when a merchant needs money fast without having to provide collateral (like their home), a type of financing option called a merchant cash advance (MCA) can be quite attractive. Companies like PayPal and Square have entered this space.

What Is a Merchant Cash Advance?

A merchant cash advance is not technically a loan, although it is similar. Think of it as a payday loan for businesses. A company lends money to a cash-strapped business in exchange for future earnings.

The way it works is that a merchant cash advance company provides a sum of money to a business, and in return, the business agrees to give the company a percentage of the business’ credit card revenue. This definition is how merchant cash advances have worked historically. The arrangement was strictly one between the payment processor that clears and settles credit card payments and the merchant. The processor is then repaid by taking a percentage of the merchant’s future sales.

This initial structuring of the cash advance has now been surpassed in popularity by an Automated Clearing House or ACH withdrawal advance. In this case, the upfront cash is repaid by debits directly drawn from the merchant’s bank account. Ironically, this connection with the bank is the source of the problem when the merchant experiences money problems.

How Merchant Cash Advances Are Calculated

A typical scenario is one where a merchant receives a cash advance with a high factor rate. This can be equated to the relationship between an individual’s low credit score and a subsequent high interest rate. For a merchant with a high factor rate, the merchant cash advance fees can be quite expensive. Here is an example:

A merchant cash advance of $60,000 with a factor rate of 1.5 means that you multiply the two numbers and come up with a total of $90,000. So the fees equal $30,000—half the amount of the initial advance! These high costs in addition to the frequency of repayments can cause cash-flow problems.

Faced with not enough money to cover all their obligations, the merchant has to make difficult choices. He or she may prefer to prioritize payroll or their office rent payment over making the MCA repayment. Unfortunately, the choice of who and what to pay first is not up to the merchant anymore—the MCA will be first in line. If the merchant’s bank account is connected to the MCA, their automated debit will continue to be made on the prescribed schedule. Similarly, if the repayment is through future credit card revenue, the processor will just grab any revenue that comes in.

Because their repayments are made regardless of the other obligations the business has, they often result in a shortage of cash to make payroll or pay for supplies. Sometimes the cash shortage results in a financial crisis of such severity that the merchant may go out of business. Before this drastic decision is made however, most merchants seek another loan with more affordable terms in order to pay off their existing MCA. This is where Credit Builders Alliance (CBA)’s non-profit lender members come to the rescue.

Merchant Cash Advance Relief

CBA has a membership of over 500 non-profit organizations. The lender members are all non-profits—many of whom have a CDFI designation. This stands for Community Development Financial Institution. These entities are certified by the U.S. Treasury Department and their mission is to lend in distressed communities.

Recently CBA has been hearing from its lender members that more and more are making loans to business owners to help pay off their initial MCA. Because non-profit lenders offer responsible loans with affordable interest rates, the new loan then becomes manageable. However, wouldn’t it have been better for the merchant to have visited the non-profit lender in the first place? The answer is unequivocally yes!

How to Find a Nonprofit Lender

Unfortunately, non-profit lenders do not have large budgets for advertising that can compete with for-profit lenders. Therefore, many of their borrowers come through referrals and not through direct advertising. You can be one of those referrals or avail yourself of their low-cost loan products. The existence of CDFIs should no longer be the best-kept secret. You can find many through Treasury’s searchable database. CBA’s “find a member” catalog is also a way to locate non-profits in your community, as is another network organization of CDFIs, the Opportunity Finance Network (OFN). Happy hunting!