Government agencies, banks and consumer advocacy groups have been trying to find ways to clamp down on the predatory nature and proliferation of payday and title loan businesses. However, hiding in the shadows is another growing industry that is taking advantage of small businesses across the U.S. They are companies offering merchant cash advance loans and are cleverly disguised to skirt the usury laws.
What are Merchant Cash Advances?
The merchant cash advance loan business is a new industry that developed during the recession of 2008 when, because the bank lending criteria became so tight, very few small businesses could qualify for traditional loans. However, these same small businesses still needed the occasional short-term cash infusion to maintain business operations.
Modeled after the payday or title loan advances, merchant cash advance loans use a business’ receivables as collateral. The receivables can be the daily credit card transactions or invoices to clients. To pay the loan back, a percentage is taken directly from the business’s checking account on a daily basis.
Credit underwriting for these companies will monitor the borrower’s bank statement to decide how much money they can take out of the borrower’s account based upon the cash flow, to pay themselves back. While many of the lenders state that there are no “hidden fees,” the pricing of these loans is never clear and usually based on very high fees. The fees are not called interest, so as not to look like a loan and to avoid banking laws.
While each of the merchant cash advance lenders competes heavily for business, most have similar terms and interest rates. To qualify, many of these lenders also force businesses to switch to their own credit card processing service, which usually charges a higher credit card processing fee than the more common processors.
The Real Cost of Merchant Cash Advances
In one instance, the Woodstock Institute, a nonprofit research organization, analyzed a number of merchant cash advances and found that borrowers often end up paying effective interest rates that can soar into the triple-digit percentages.
In one case, a provider gave an advance of nearly $24,000 to a business, charging more than $1,100 in fees for things like issuing the advance, risk assessment and processing. To collect its payments, it deducted $499 a day from the business’ sales for 76 days.
In total, the borrower paid nearly $37,500, paying an effective interest rate of about 346%
When Small Business Borrowers Can’t Make Payments
If businesses miss a payment or can’t keep up with the payments, things can go awry quickly. The
automatic deductions will continue as long as there is money for the cash advance company to withdraw. In many cases, the loan company has the right to call the loan all due and take all of the money out of the account the next time funds are available.
Many business owners take out new advances in order to pay off outstanding balances on previous advances, plunging them into a cycle of debt. Unfortunately, many of those businesses are forced to close their doors for good.
The Need for Regulation
The problem with advances is features normally regulated by the government – fees, penalties and rates, aren’t subject to any oversight. In addition, the terms of the advance aren’t always clearly outlined and the total amount owed, including the hefty fees and charges that are tacked on top of the initial advance aren’t usually expressed as an annual percentage rate.
Another problem small businesses face is after a business owner takes out one advance, they are often bombarded with offers for more. It seems the industry players are so closely related, they almost conspire to get a small business owner in trouble.
Using Merchant Advance Loan Prudently
There are times a business has no other choice but to go down this path. And while expensive, they can make sense, if the cash flow is available to pay back quickly. Some reasons to choose this method might include:
- Payments need to be made to avoid damaging credit but the timing of funds owed to you are delayed;
- Supplies and materials are needed to fill a customer order and no other credit facility is in place;
- Equipment is needed immediately and there is a clear strategy to permanently finance the equipment;
- Your personal credit is damaged and there is simply no other choice.
In many cases, the need for speed is the only answer. Planning and preparation usually mitigates the need, but if you find yourself in the position for this type loan, seek the advice of those knowledgeable.
What’s a Better Alternative?
An alternative to borrowing money from merchant cash advance lenders may be to apply for a loan guaranteed by the US Small Business Administration. The drawback for a company needing immediate cash is that the application process is like a traditional bank loan – not very fast and requires the development and approval of a business plan, which also takes time to write. If your loan request involves the acquisition of a business or construction, timelines lengthen.
Fortunately our team at Banks & Associates can help finding financing solutions to even your most difficult money problems. We pride ourselves in providing our clients with fast financing with flexible terms that ensures you can make payments without fear of having to close your business.