One of the first rules for survival in the Wild West also applies to business- resourcefulness, or making the best use of what you’ve got- is one of the best ways to make sure you survive tough times. With loan default rates higher than they’ve been in quite a while, traditional financing is becoming harder to find, especially for new or smaller businesses. If a loan is not an option, what can you do?
One option is a merchant cash advance. Cash advance transactions work a bit like loans- you apply, agree on rates and advance amounts, and then begin repayment. The “advance” that you receive is paid back automatically out of your daily credit card sales. You have to meet certain qualifications to be eligible, namely, accepting credit cards. Many providers also require that businesses have a solid financial history, existing equipment or property leases, or certain credit scores to qualify. Still, advances are much easier to qualify for than traditional loans- in some cases up to 90% of applicants are approved for amounts into the hundreds of thousands of dollars.
If this sounds easy, or too good to be true, you’re half right. Merchant cash advance transactions can be expensive, carry onerous repayment terms, and are sometimes pushed on businesses that barely qualify by less-than-honest lenders. Still, an advance might be the only financing alternative available to some businesses. Here’s a practical rundown on business cash advance providers that can help you choose between the good, bad, or downright ugly:
THE GOOD:
Good providers are known by their reputation. To check out how a provider stacks up, see if they’re registered with the Better Business Bureau and find out if any complaints have been filed. Many merchants file complaints against unscrupulous providers with the Federal Trade Commission, another place to check. The North American Merchant Advance Association, a self-regulated organization of merchant advance providers, also provides information about industry standards and practices, and allows for complaints against providers.
In addition to these sites, it never hurts to ask for references directly from a provider or to do a quick online search for more information. Good providers don’t charge application fees or guarantee automatic approvals. If a provider has a “clean” record on all these counts, they’re probably a safe bet.
THE BAD:
Even if you’ve checked references and the company seems like a reputable advance provider, you’ll still need to make sure that your individual service agreement is fair. Here are a few red flags to look out for:
- Hidden fees: Monthly minimum amounts, penalty fees, and other charges add up very quickly. Make sure you’re aware of all possible fees before signing a service agreement.
- Merchant account compatibility: Reputable companies generally have agreements with different merchant account providers- you probably won’t need to switch your merchant services account in order to get an advance. Be wary if you’re asked to do so.
- Balloon repayment: Providers usually take a percentage of daily sales until the advance is paid off. If a provider requires full, or balloon, repayment for any reason (daily sales below a certain amount, a certain date passed) be extremely cautious about entering into an agreement.
THE UGLY:
While most merchant advance transactions are smooth, fast, and simple, they can get complicated if you agree to certain provisions in your service agreement. Here are a few things you should avoid:
- Pledging collateral, or giving the provider access to bank accounts as reserves for repayment. Things can get ugly pretty quickly if you aren’t able to repay the advance as scheduled- providers can take money directly from your business checking account, seize, or place liens on business property, and take other drastic actions. Make sure you’re protected by the contract you sign.
- Flexible retrieval rates. These allow the provider to take more out of your daily sales amounts than is safe to continue operating your business.
Merchant advances can be a beneficial source of alternative financing for businesses that need cash for operations, business opportunities, or other expenses. Working with a reputable provider is one of the best ways to make sure you get the financing you need without incurring additional costs, penalties, or fees.
Isn’t this just creating a huge future problem to find a short term solution? A company that is already strapped for cash is going to be more strapped for cash once they have to pay back a loan at high interest rates, plus fees associated with it. I know cash advances are a terrible idea for people, I wrote a post about it here: http://www.artofthecoupon.com/cash-advance-credit-cards/
in which I argue that you should not take a cash advance to support a life style you clearly can’t afford. Can’t a similar argument be made for businesses- unless there is a clear influx of cash coming in,s shouldn’t companies do anything else (cut costs, limit expansion, etc.) to avoid getting a loan until they can find credit that won’t cripple them in the future?
Thanks for the comment- you’re right about being wary about cash advances, which is the heart of this post- they’re not ALL bad. Sometimes it actually does more harm than good to cut costs in certain areas. Cash advances are best for businesses with a steady, predictable sales volume that are temporarily low on operating cash (for example, those that just purchased expensive equipment to take advantage of tax savings).
A merchant cash advance program is not designed for companies that are skirting the edge of going under. The ideal company is one that is doing good and has an opportunity to do better with a cash influx that will allow them to expand in some significant way.
Sometimes “waiting” until things improve will cause a business to miss an opportunity that their competitor will be happy to seize.
A merchant cash advance program is great for partner buy outs. For example if a partner wanted to purchase the business from a relative or boss they could do so. You are right, a mca is not a loan and will not show up on the balance sheet as a loan but rather a cash advance.
This money could then be used to make a downpayment on a building or equipment and counts as the owners equity share.
I’m a small business owner considering using a merchant cash advance. We have a pretty predictable amount of sales coming in – but its just not as busy as we’d like it to be (we just relocated and a lot of customers got lost in the shuffle) so an influx of cash will allow us to do some advertising and beef up our inventory a bit to make sure we don’t miss any opportunities of gaining a new customer. It’s hard to understand a business’s reasonings for choosing to do something like this unless you’ve been in the position of a small business owner with very few options in a tough economy.