Merchant Cash Advances: The Pros and Cons

The economy has been tough on a lot of businesses, and the credit crunch has meant lean times for many business owners who are struggling to keep their businesses open until better times come again.

If you are in a cash crunch and need some working capital as soon as possible, a merchant cash advance may be one option worth considering. As with any form of loan, there will be pros and cons, but it could provide you with a short-term solution to your cash crisis.

Merchant cash advances are loans designed for businesses that have cash flow but no collateral, that is, no security they can provide upon the loan. Types of businesses that might uses merchant cash advances include retail shops whose goods can’t be liquidated at auction, service businesses with no actual inventory, or any business that has regular income coming in, but nothing tangible and no lines of credit, such as an online business selling digital goods.

The merchant cash advance company will loan the business a certain sum of cash to use as working capital. In exchange, the business signs an agreement that allows the merchant cash advance company to take a percentage of their credit card sales automatically every day until the loan is repaid, plus a fee for processing the loan. The amount taken will usually be between 5% and 10% every day, but can be as high as 20% depending on the amount of the loan and the level of risk involved.

The cost of merchant cash advances is far greater than that of any regular small business loan. Translating it into an annual percentage rate (APR), many merchant cash advance interest rates will be in the region of 30% APR to as high as 50% APR.

In addition, you need to look out for any additional costs, such as the legal costs of having the contract reviewed by a lawyer, closing fees and so on.

We all know that there is no such thing as easy money, and a merchant cash advance is no exception. However, every business is different. If you are considering applying for a merchant cash advance, think carefully about the situation of your business, the volume of transactions and value of sales you do every day, what you intend to use the lump sum of money for, and how much the cash advance company plans to charge you in terms of APR and fees.

If you plan to use the cash advance to invest in projects or assets that will allow you to earn more money in the near future, a merchant cash advance may be a good investment. However, keep in mind that you will be liable for the debt regardless of whether your improvements pay off.

Consider all of your other options before considering a merchant cash advance. Talk to several banks, go to the Small Business Administration website to see if there are any grants or loans available to you at a lower interest rate, or consider raising more capital through ‘bootstrapping’, or angel investors. Also consider bringing additional streams of income into your business quickly, for example, through affiliate marketing.

Having said that, one of the main advantages of merchant cash advances is their availability. These companies specialize in loans to businesses that most banks just will not touch because they have no security and are therefore considered too high-risk. Since the credit situation in the U.S. is quite tight right now, and likely will continue to be so for quite some time unless you have an almost spotless financial record, merchant cash advances may be the only option for businesses without the type of collateral most banks are looking for.

If you decide that the only solution to your cash crunch is a merchant cash advance, talk to at least three companies to see what kind of loan terms they are willing to offer. Read all the fine print, calculate the rates and watch out for any hidden fees.

Merchant cash advances can prove to be very expensive loans for businesses. However, if you have no other way to fund your business and expand rapidly, then take the best deal you can find and do whatever you can to ensure an even greater cash flow in your business to pay off the loan as quickly as possible.

Further Reading
YOUR RECESSION SURVIVAL GUIDE: How to Save Money and Even Boost Your Income in This Recession (Money Matters)

How to Create Wealth to Grow Your Business (Business Basics)

Investment and Financing Strategies: Angel Investors (Money Matters)

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