Merchant Cash Advances: Loan Sharks Give Better Rates
Most businesses go through a rough patch, where they need to find money to meet payroll, pay rent or buy inventory. There are a number of ways that a business can get a lump sum of money to be paid back over a few months. However, the effective interest rates at which this money is available make the “loan sharks” that appear in mob movies look like reasonable businessmen. While the providers of these loans will not break your legs, they have better, more sophisticated ways of getting your money.
Over the last decade, merchant cash advances have become a popular way for retail stores and restaurants to borrow cash. The title “merchant cash advance” is purposely disingenuous. The providers of these loans are trying to get around state and federal usury laws. These laws, which are intended to protect people from unscrupulous lenders, typically prevent lenders from charging an annualized rate of more than 36%. By legally structuring the transaction as the purchase of future revenues derived from credit cards, the providers of merchant cash advances can charge an effective interest rate between 40% and 100%, although there are some cases where the rate is as much as 200%.
Unlike a loan shark, merchant cash advance (MCA) providers don’t have to break legs to get paid. Every time a client does business with the retailer or restaurant by credit card, the MCA provider will typically get paid 10-20% of the transaction value. When the retailer takes the “loan”, they agree to let the MCA provider get paid directly by their credit card processor. Unless the merchant stops taking credit cards or goes out of business, money will go towards paying off the MCA provider. (One of the “good” things about MCA advances is that if you legitimately close your business, they cannot go after you personally for the money.)
If a business is struggling, a merchant cash advance will generally hasten its decline by significantly reducing the firm’s revenue for about 6 months without any reduction in costs. Before taking a merchant cash advance, a retailer should carefully consider if the problems the company are facing are truly short-term, or if there needs to be a fundamental change in the business. A merchant cash advance can help postpone making a difficult decision about a business and put a business in a weaker position to make changes.
If you're looking for additional ideas for short-term financing, I provide a review of other options in Working Capital: How To Raise Money For An Existing Business.
