Merchant Cash Advances in a Nutshell

What are Merchant Cash Advances?

 Merchant Cash Advances are a form of alternative lending, particularly for small businesses that have been rejected by larger financial institutions. The less stringent eligibility requirements does not only make it easier for smaller businesses to qualify for Merchant Cash Advances, but also have access to funds much quicker than traditional lending. However, the differentiating characteristic of a Merchant Cash Advance lies in the payment structure. A Merchant Cash Advance is repaid through a percentage of the daily credit card sales as agreed upon in the Merchant Cash Advance agreement.

What to Look for in the Merchant Cash Advance Agreement?

Your Merchant Cash Advance agreement will indicate the terms and conditions of the transaction. It is important to remember that once you sign your Merchant Cash Advance agreement, you are binding yourself to the agreement. Needless to say, it is your responsibility to thoroughly analyze the agreement and challenge it. It is the responsibility of the Merchant Cash Advance lender to be as transparent as possible and address any of your concerns regarding your Merchant Cash Advance agreement.

Personal Guarantee

Although your merchant cash advance lender might want you to believe that signing a Personal Guarantee is standard procedure, it is not. You have the legal right to object to signing a Personal Guarantee. However, if you do sign a personal guarantee, it is important to understand you are granting permission to the Merchant Cash Advance lender to seek relief on outstanding Merchant Cash Advance payments by suing you in your personal capacity. This means that if after suing the business entity, debts are still not satisfied, the Merchant Cash Advance lender may come after your home and personal possessions.

Acceleration Clause

Yet another condition to be wary of in your Merchant Cash Advance agreement is the Acceleration Clause. It simply means that when you defaulting on your payment makes the principal amount due immediately, not just the missed payment. If you signed both a personal guarantee and an acceleration clause can have an adverse effect on both your personal and business finances. Since the lender is now entitled to claim the full amount of the advance leaving your personal finances vulnerable.

Confession of Judgment

Confessions of judgment can be very tricky because they give lenders a substantial amount of legal authority. Signing a COJ permits the lender to enter judgment without a lawsuit once certain conditions are met like in the case of a default.  Essentially, it’s like pleading guilty to defaulting on a payment before you actually do.  The Merchant Cash Advance lender doesn’t have to waste time proving you defaulted, because you’ve already “confessed” by simply signing the COJ.

Upon default, the lender can get a court judgment to collect without notifying the you. Without a lawsuit, a lender can collect the amount due from any source of the borrower’s income. It can be very difficult to dispute these actions in court when there is a signed Confession.

Advantages and Disadvantages

Like any other undertaking that may affect your finances, Merchant Cash Advances  have both advantages and disadvantages.

Advantages of Merchant Cash Advances

  • Even applicants with low credit scores can get Merchant Cash Advances. Traditional lenders may reject applicants with a bad credit score. However, perhaps one of the most attractive features of Merchant Cash Advances is that entrepreneurs with low credit scores may still be approved.
  • The approval rate for Merchant Cash Advances is higher. Because Merchant Cash Advances are not based on personal credit, approval rates are much higher. Also, Merchant Cash Advances are not traditional loans, as such lengthy paperwork is not required.
  • No collateral or credit is at risk.  Since Merchant Cash Advances are not traditional loans, lenders are not required to provide collateral and are also not reported on credit reports.
  • Simple application process. Requests for Merchant Cash Advances can be processed much faster than traditional loans which can take weeks to be finalised.
  • Straightforward and hassle free payback process. How much you payback your lender is based on a percentage your revenue and not a fixed amount making it more manageable to keep up with payments.

Disadvantages of Using Merchant Cash Advances

  • 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.
  • The Merchant Cash Advance rates are substantially higher than traditional loans. Although Merchant Cash Advances do not have an interest fee, if compared to one, the rate you will be paying for Merchant Cash Advances is much higher. Experts find that the rate of Merchant Cash Advances can range between 60% and 200%. The fee may be at much 30% of the Merchant Cash Advance. For example, the fee for a $30,000 advance may be $9,000.
  • The Merchant Cash Advance industry is not as regulated as banks. This means that there is more room for predatory lending practices. Federal and state laws have stringently regulated banks to protect borrowers from being preyed on. Since Merchant Cash Advance providers are technically purchasing  future receivables and not providing a loan, they are not similarly regulated. As such, they are exempt from state usury laws that would otherwise prohibit charging fees that greatly exceed industry standard interest rates. This shortfall of regulation has led to many unethical practices such as Merchant Cash Advance lenders providing funds companies that may not have the ability to repay  repay and also cases where the  Merchant Cash Advance company changed its billing procedures without informing borrowers.
  • Most merchant cash advances  prohibit switching credit card processors.  If you are unhappy for some reason with your credit card processor, you are stuck with them for the duration of your Merchant Cash Advance obligation.
  • Restricts encouraging your customers to pay in cash. In order  to avoid a percentage of their sales going to the MCA firm, borrowers are prohibited to encourage cash sales. Such activity is considered a “breach of contract” and could result in litigation.