Pros and Cons of Merchant Cash Advance Loans

Business.com / Funding / Last Modified: February 22, 2017

Understand the nature of merchant cash advance loans, their typical requirements, and what their advantages and disadvantages are.

A merchant cash advance loan is a quick source of short-term financing for a small business merchant with an immediate need for cash. Most advances -- plus fees -- are repaid in within six to 12 months.
The primary requirement is you must make daily credit card transactions (which is why they are merchant cash advances, i.e., advances to retail, restaurant and service companies).
Additional conditions may apply. These include:

  • $2,500 to $5,000 monthly credit card billings, possibly higher depending on the amount of the advance.
  • Proof of at least four months history of credit card sales.

If your business meets these conditions, here are the pros and cons of obtaining this type of loan.

Advantages of Using Merchant Cash Advances

The advantages of a merchant cash advance include:

  • Unlike with a bank loan, there is no fixed monthly payment, no interest rate or payoff date.
  • There is no collateral requirement. In the event the merchant's business fails and full restitution for the advance not made, the owner's assets are not at risk, as they would be with a bank loan. In fact, if a merchant's business fails and the cash advance is not fully repaid, there is no legal liability.
  • Repayment is performed automatically based on the merchant's credit card transactions; consequently, there is no possibility of late charges from overlooked due dates that frequently occur with bank cash loans.
  • Almost instantaneous access to funding; advances are typically made within 24 to 48 hours.
  • Better cash flow; if sales are slow for a given month, you pay less to the MCA company because they collect only a set percentage of monthly sales, without any minimum amount required.
  • Minimal paperwork.
  • If you need cash quickly, but don't qualify for a traditional bank loan, or can't wait for a loan decision and/or release of funds.

Banks have been stingy with lending to small businesses since the beginning of the financial crisis that began in 2007. While the economy has improved since then, credit availability has not eased up at all. Given a tight credit market, small businesses have to take advantage of whatever resources they can find. Merchant cash advances are a novel workaround to unavailable bank lending.

Disadvantages of Using Merchant Cash Advances

The catch (you knew there was going to be a catch, right?) is that a merchant cash advance is considerably more costly than traditional financing.
Technically, merchant cash advances are not considered "loans." Rather, they involve the purchase and sale of future income. The advance never lasts more than a year, so the firms putting up the financing don't have to follow regulations on interest rates that traditional lenders are required to follow.
Still, while technically not an interest fee, if you compare it to one, the rate you are paying with an MCA is significantly higher. Tozzi notes that Leonard C. Wright, CPA and Money Doctor columnist, estimates the equivalent APR (annual percentage rate) for a merchant cash advance fee can range between 60% and 200%.
One reason the APR is so much higher is that a bank receives a monthly percentage on the balance owed, not the full amount of the loan. As the loan is paid off and the balance reduced, the interest paid is less. However, a merchant cash advance fee is a fixed charge for providing the advance. That charge can be as much as 30% of the advance. For example, the fee for a $20,000 advance could be $6,000.
Banks are regulated by federal and state laws intended to protect consumers against "predatory" lending practices. MCA providers are not similarly regulated because they are technically buying future receivables, not providing a loan. Consequently, they are exempt from state usury laws that would otherwise prohibit charging fees that greatly exceed industry standard interest rates.
This lack of regulation has led to some unscrupulous practices. These include companies advancing more money than a business has capacity to repay and cases where the cash advance company changed its billing practices without notifying the merchant borrowers.

Other potential disadvantages include:

  • Most cash advance contracts prohibit switching credit card processors; if for some reason you are dissatisfied with your credit card processor, you are stuck with them until the advance is repaid.
  • Encouraging your customers to pay in cash, to avoid a percentage of their sales going to the MCA firm, is considered a "breach of contract" and could result in litigation. 

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