Reliable cash flow is necessary for your small business to succeed. When times are tight, a merchant cash advance can be a tempting option. However, there are several drawbacks to this loan alternative that could wind up hurting your business which we will discuss below.
A merchant cash advance provides a set amount of funds in exchange for a percentage of future credit card sales. That means every time a customer pays by credit card, a portion of the sale goes to the lender and not into your business account. This means sacrificing a significant chunk of potential profits for an entire year or until the full amount is paid back.
Since a merchant cash advance is paid back through credit card sales, you don’t have to worry about trying to scrape together funds for a monthly payment when things are slow. However, a large volume of sales means you pay the advance off faster. It also means that you can’t save up money when business is booming and use it to spread things out for a more consistent payment schedule.
If you consider a merchant cash advance in terms of actual cash flow, it’s almost like you’re not getting any money at all. The moment you receive the funds, you have to start paying them back. Although every type of loan operates this way to some extent, the method by which a merchant cash advance is paid back means that the amount of available funds gets smaller more quickly than with other methods.
The structure of a merchant cash advance creates a highly variable APR that makes it much more expensive than a loan. You may get an advance with a term of a year, but if you pay it off before then, you may find yourself with an APR over 100 percent. With no early payment bonuses to offset this, you could end up worse off than if you’d never gotten the advance.
Cash advances come with a set of contingencies that you need to observe for the duration of the payback period. These may include restrictions on taking out other loans, moving or closing your business or the methods you use to handle credit card sales. Since this type of lending isn’t regulated, there are no rules in place to prevent lenders from setting their own terms, even if those terms hurt your business. Despite how attractive a merchant cash advance might seem when your business is hurting for money, you’re better off choosing a more stable option. Bank loans, lines of credit, alternative loans and refinancing are all viable alternatives that allow you to keep operating and have regulations to protect your business from unfair loan practices. If you are ready to learn more about business financing options available to you, contact us today.