How Multiple Cash Advances Can Lead to Bankruptcy

If you are thinking about taking out your first (or second) merchant cash advance, this post is for you.

We’ll explain the pros and cons of taking out a cash advance and how multiple cash advances can eventually lead to cash flow problems and even bankruptcy.

merchant cash advances can lead to bankruptcy

The Difference Between a Bank Loan & a Merchant Cash Advance

A traditional bank loan is perhaps the safest business financing to secure. Banks tend to have the most affordable and predictable rates, terms that are fixed and fully disclosed, and the lowest possibility of being bought or sold. In exchange for the stability, you will have to meet strict requirements including the need for collateral.

These bank loans allow a business owner to borrow money for an agreed upon period of time with a set interest rate that renders payments that do not change over the term of the loan. The time involved from application until approval can range from 6 weeks to 6 months.

A cash advance is a method of short-term financing in which the cash advance company purchases a portion of a company’s future credit card sales at a discount. Repayment is made via a percentage of the company’s daily Visa and Mastercard reciepts. Turn around times are much shorter and there is no collateral required.
A merchant cash advance is not a loan.

Pros and Cons of a Merchant Cash Advance

Bank loans are highly regulated by the government to ensure no predatory practices are put into place. A merchant cash advance is not a  loan—rather, the purchase of a portion of future credit card sales at a discount. Therefore merchant cash advance companies claim that they are not bound by state usury laws that limit lenders from charging high interest rates. This technicality allows them to operate in a largely unregulated market and charge much higher interest rates than banks.

Pros of a Merchant Cash Advance:

  • Fast approval even if you have less than perfect credit
  • No collateral required so your assets are not at risk if you fail to repay
  • Minimal paperwork necessary for application and approval
  • If all of this sounds too good to be true, it’s because it is for most business owners.

Cons of a Merchant Cash Advance:

  • No government or industry regulation on interest rates leading to predatory practices
  • APRs can fluctuate between 30% and 200%
  • Repayment amounts are not fixed – the more you make, they more they take
  • Since repayment amounts fluctuate depending upon sales volumes, the payback term can wind up being as short as 5-6 months
  • Advance amounts are calculated using the company’s credit card sales only, not their total sales
  • A cash advance can not be paid off early unless the business owner pays the entire balance with no discount

Because cash advance companies are willing to lend to high-risk borrowers, they charge very high rates to ensure they make a profit even if a borrower defaults.

How a Merchant Cash Advance Can Lead to Bankruptcy

Because the merchant cash advance industry is not regulated, it can be very easy for a business owner to take out multiple cash advances at the same time.

One cash advance on its own will likely cost your company a significant amount of money from the high rates and short repayment term. Having two or more cash advances can easily push you to the brink of bankruptcy.

Consider that each cash advance company will be taking a (hefty) percentage of your credit card sales as payback. If you have two cash advance companies taking up to 30% each from your credit card sales, you’ll only end up with 40% of your sales as revenue to pay your bills and employees. This will likely lead to cash flow problems and you’ll need to take out a third advance leaving you with only 10% of credit card sales as revenue.

You can easily see how this vicious cycle can spiral out of control and lead you down the road towards bankruptcy.

To avoid this, we suggest you consider alternatives to merchant cash advances that have the benefits and stability of a traditional bank loan, without the strict requirements.

A Working Capital loan is one such option that can provide your company with more stability than a cash advance, and unlike a traditional bank loan, there is no collateral required.

A working capital loan obtained through ARF Financial’s network of partnering banks provides you with many advantages over a merchant cash advance.

First, loan approval amounts are typically higher since they are calculated using your total sales not just credit card sales.

Secondly, interest rates are typically much more affordable and are fully disclosed up front and do not change. Loan terms are fixed and are available up to 24 months rendering lower payments that do not fluctuate. Additionally, re-payment is not linked to your credit card receipts, the interest paid is tax-deductible and there is no penalty for paying off early!

Take a moment now to learn all about the working capital loan approval & payback process and then get in touch when you’re ready to get approved for your loan.