Merchant Cash Advances or Lack of It

Scam or Legitimate:

Merchant cash advances have quickly attracted their share of both praise and criticism from industry observers who argue over whether the services ethical or not. One argument is that merchant cash advances are scams that prey on desperate business owners. The other argument is that they are low-risk funding options for business owners that don’t qualify for traditional bank loans.
The answer lies in the eye of the beholder. Both arguments make valid points and to gain understanding as whether a merchant cash advance is a legitimate form of business financing it is important to be educated as to what a merchant cash advance is.
Is a merchant cash advance a loan?

Technically, no but they do have a few similarities. A merchant cash advance is the sale of a merchant’s projected future credit and debit card sales. The merchant agrees to sell a percentage of his future credit and debit card earnings for an agreed upon price that includes interest. The merchant cash advance provider, then receives a daily percentage of the merchants’ earnings from credit and debit card sales. Even though they sound very similar to loans they are technically different because the repayment is based on sales and they aren’t subject to the usury laws that have been put into place to prevent predatory lending practices. In other words, there are no regulations in place to put a cap on interest rates or fees charged by the providers. Some observers argue that this is a terrible deal while others see no issue with the practice so long as the merchants receiving the financing are properly oriented to all of the terms and enter into the agreement of their own devise without being coerced.

Merchant cash advances are typically repaid daily through seamless deposits taken from a credit and debit card sales instead of monthly installment payments. Rather than setting aside a specific amount of savings each month for upcoming loan payments, the merchant simply allows the provider to debit a percentage of each day’s credit and debit card sales. Another feature that some observers have issues with is that merchant cash advances don’t require collateral and the provider is at risk of not being repaid. Merchant cash advances are neither as dangerous nor as safe as observers claim. As with any business transaction, there are possible risks involved:

  • The interest rates associated with merchant cash advances often exceed the maximum allowable rates than traditional lending sources permit.
  • With cash advances being repaid using a business’s daily sales, a business’s revenues can be greatly reduced during the repayment period. However, on the other hand incoming revenue may be so strong and steady the business doesn’t notice a reduction in revenue.
  • Merchant cash advances are often marketed to business owners with poor credit and/or limited collateral and have potential to trap merchants into bad deals. However, on the other hand, they are also marketed to profitable businesses that simply don’t have the luxury of waiting on a traditional lending institution to approve them for a loan.
  • Merchant cash advance providers typically don’t charge monthly fees or late penalties, so any provider that does is probably attempting to execute a scam.
  • An ongoing concern from both sides of the argument is that when a business allows a merchant cash advance provider to debit their payments from the business’s credit and debit card systems it opens the door for fraudulent providers to obtain customer credit and debit card information.
  • Legitimate merchant cash advance providers will allow businesses to repay their advance through split withholding, lockbox withholding, or ACH withholding rather than attempting to coerce the borrower into allowing the provider access to their credit and debit card systems.

Ways to avoid merchant cash advance scams:

1.) Merchants should make sure that they understand what they are getting into because the transactions aren’t covered by lending laws and there is limited protection for consumers.

2.) Merchants should shop around and get quotes. There are a lot of merchant cash providers, and like with any other business some will offer better deals than others.

3.) Merchants should become acquainted with the business and know their potential providers in order to make an informed decision about the provider they choose to work with.

4.) Merchants should make sure that they understand the terms of the contract.

5.) Merchants should look for hidden fees such as: monthly/late/penalty fees, balloon payments and indemnity clauses, and flexible withholding rates.

6.) Merchants should investigate merchant account compatibility to ensure that they are able to work well with the provider they choose.

7.) Merchants should never allow access to their bank accounts. A provider with access to a merchant bank account has the ability to withdraw money without prior notification.

Merchant cash advances are no different than any other type of financing, there are good providers and bad providers. Unfortunately, there isn’t a single form of business that is immune to scam artists who are experts at taking advantage of good people. Where most businesses have laws that protect consumers’ merchant cash advances don’t so it can be a risk either way. Business owners who are skeptical of the practice could possibly miss out on great business opportunities and business owners who aren’t careful enough could very easily be taken advantage of and lose their entire business. In dealing with merchant cash advance providers it can’t be stressed enough that merchants need to find a good middle ground and be careful not to go too far to either end of the spectrum.