Merchant cash advances are one of the most sought-after ways of getting a little money to start up a small business, especially since it does not involve any hassle. It gives an overall impression of a good deal as you get to fill out the documentation online, and there is not much required. Plus – you can get cash the same day. But what many people forget is that they need to look out for the cautions involved and the fine print that goes with a merchant cash advance. This is because if you compare them properly with the other options available, you will find them to be one of the most expensive ones as well.
This is because of the cost that merchant cash advance comes with and the fact that it does not need to have many levels of qualification. This is also why many people have started to scrutinize the financing option. People have begun questioning the regulations attached to it and in this article, we will guide you through the whole thing.
What is Merchant Cash Advance
Merchant cash advances are different from any other types of financing options that you will find in the market. Even though many people like to call it a loan, it isn’t technically that. As the name says, the merchant cash advance is an advance funding provided to your business by the agency. But the only thing they ask for is that you give them a small amount from your future sales as the agency is technically purchasing your credit card sales. When you apply for the advance and you get it, you settle on a small percentage that the company will take from your every day or week credit/debit card sales. This process will continue until the agency has regained the amount of money that they gave to you in the first place.
Rates and Merchant Cash Advance
When you consider rates in merchant cash advance you will mostly be getting factor rates instead of interest rates. Factor rate is a number (much like the interest rate) but in decimal form. You will find that the average factor rate charged by an agency will be around 1.2 or 1.5. once you have been given a factor rate for the advance, ensure that you multiply that number with the advance amount that you are taking from the company. This will tell you the amount of money that you will have to pay extra. You can also add it to your advance amount to know exactly the amount of money you will need to repay them.
Also, keep in mind that the number of this rate will change according to the risk your business holds. The more the risk associated with your company, the more the factor rate will be. If the agency feels that you will be able to fulfill the payments in time then they will give you a lower factor rate, but this will lie between the scale mentioned earlier. A steep factor rate on a riskier business helps the agency ensure that they are able to get their money back even if your business defaults. This is all to ensure that the agency is also safe and gets its money back in time.
Example of Merchant Cash Advance
Now we will take a look at a small and simple example of merchant cash advance. If your business is to run a small bakery and you need a capital of about $25,000, you will not need to wait for a bank to give you a loan, and with most financial institutions you will not be able to qualify for a loan. This is mostly because there isn’t enough history associated with your business for them to take a chance. The next best option for you is to seek out the help of a merchant advance agency. The agency might be able to give you the amount you require with a factor rate of 1.3. This means that you will have to pay $7,500 extra and in total $ 32,500.
But then there is a time limit to associate with the return of payment. The number also depends on the credit card sales that you make daily as the percentage you need to pay back at the end of the day can be higher than what you might like to give. Overall, the entire amount is more expensive than what the other options might hold for you.
Things You Should Keep an Eye Out For
There are many benefits to this type of finance, especially if you have a small business which is a startup or is relatively new in the market. If you are unable to qualify for a bank loan or any other type of financing option, then the merchant cash advance is the best thing for you. For business entrepreneurs who solely rely on their business for getting through their expenses, then merchant advance cash is there to save the day for them. But there are a few reasons why you should take care when applying for the advance. Some things you need to look out for are:
- High APRs – in the beginning when you get a factor rate associated with your merchant cash advance, things may not look that bad. But once you convert that into APR you will be surprised by the costs shown. Usually, there are three digits associated with APRs which is considered to be expensive. Make sure you are careful when you accept the APR.
- High payments to be made on the daily basis – the good part about the merchant cash advance is that they charge a fixed percentage of your daily credit card sales. So the good thing is that if you are having a couple of slow months then the number that they will take from your sales will be low as well. But if it increases then the amount deducted will increase as well. For businesses that are cash-strapped, such high businesses can hurt the cash flow. And since APR is dependent on the pace of your advance then higher sales will be that the APR is high as well.
- Debt cycle – debt cycles can make the cash advances a bit dangerous. The problem is that since they are expensive and need to pay back as early as possible, there are possibilities that you may need to take another loan just to be able to pay for the advance cash. But the more cash advances you take, the more strain your cash flow with a witness, which then increases the chances of default.
Merchant Cash Advance Regulation
Many people wonder whether there is any merchant cash advance regulation or not, and the answer to that is no there isn’t really a regulation that looks after merchant cash advance.
Merchant cash advance is a sale instead of a loan. This is the reason why they are not subjected to the same federal regulatory oversight that the other lenders are under. Other financial institutions such as banks are bound by the law which is why they cannot provide high-interest rates. The fact that merchant cash advance agencies are not lenders is why they do not have to abide by the laws and have a freer hand at charging higher interest rates or factor rates. However, a regulation of the agencies does come from a uniform commercial code in each state, but these do not have to follow the same laws or regulations as the Truth Lending Act or the ones that other financial institutions have to follow.
Will there be a regulation moving forward?
One of the reasons that merchant cash advance has come under so much scrutiny is because it has become very popular and because everything is done online. It is because of this scrutiny that people are wondering whether there will be any regulations around it or not in the future. As of right now, in terms of the amount of interest being charged, it doesn’t seem like anything along those lines will happen any time soon. This is will stay so especially because they are purchasing receivables instead of giving out a loan. Thus, they do not have to abide by the laws that other financial institutions do.
However, there is some hope in the market that the industry will get some self-regulation in place. Even though it may be a way of avoiding future federal regulation, it can get the industry to step in the right way. The self-regulation will help ensure that the costs are presented transparently and there are some important documentations and training on selling the products. However, it is necessary that a government regulation comes in place to ensure that the online lending is being done correctly, but it is not necessary that this regulation is specific to merchant cash advance.
It the regulation does happen any time in the future, then it will require companies to abide by limitation to the rate, disclosure of the rates, and ways to prevent high-interest rate lending. It will help protect small businesses and legitimize the industry as well.