Why a Merchant Cash Advance May Not Work for You

Posted by Factor Funding Co. on March 16, 2017

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When starting your own business, it’s crucial to examine your financial options. Most business owners have several, but are drawn to a few popular ones. Merchant cash advances are one of the most frequently used financial options for small businesses. Although they carry many advantages, a merchant cash advance isn’t the best choice for every business owner. Before deciding on a merchant cash advance, it’s vital to do your research, examining the cons as well as the pros.

The Devil’s in the Details

In a merchant cash advance (MCA) deal, the business owner receives an advance amount, usually a lump sum of cash measured against future credit card sales. The business owner agrees to give invested merchants a percentage of future credit card sales in exchange for that lump sum. However, the cash advance itself is not the only detail to consider. MCA deals also involve factor and retrieval rates. These reflect not only the percentage of credit card sales a business owner agrees to pay a merchant, but also the total amount the business is expected to pay back when the lump sum runs out or payments come due. Sometimes, business owners are not prepared to deal with factor and retrieval rates. If you are just starting a business or anticipating a slow market, you might reconsider an MCA deal because you could be paying off the cash for months or years.

What Will an MCA Deal Solve?

This is a key question to answer before entering an MCA deal. Some business owners assume the lump sum associated with MCAs will solve many business needs, but it runs out faster than they anticipated. Additionally, business owners sometimes set aside MCA funds for the wrong things. You might earmark MCA funds for a new coffee machine for your bookstore and coffee shop, only to discover you are losing customers because you aren’t stocking new releases fast enough. If you’ve already spent part of your MCA funds on the coffee machine, you may not recoup your losses in time to win customers back or get new ones.

In addition, don’t enter an MCA deal simply to handle a short-term problem. Many business owners panic when their markets and cash flows dwindle and enter MCA deals without clear goals. When the cash flow crunch ends a short time later, they have debt and payments they didn’t have to incur. Before getting an MCA, look carefully at how your market works. Are cash flow crunches normal at certain times? Do certain products always sell better than others, and can you focus on developing and selling them instead of getting an MCA? Answering questions like these can save you time, money, and potential debt.

How Much Control Should You Give Up?

People start small businesses because they want to work for themselves, to look in the mirror and see the boss every morning, and to do what they’re passionate about. A merchant cash advance may take some of that control from you, however. Merchant cash lenders often put terms in their contracts delineating how business owners can interact with customers. For instance, you may be forbidden to discourage customers from using credit cards because you’ve promised a merchant a percentage of credit card sales. You may be unable to pay off pressing credit card debt if you owe money in an MCA. A merchant may add terms to his or her contract stipulating what incentives you can offer, which may keep customers away and prevent you from developing new ideas.

How Much are You Willing to Spend?

Merchant cash advances are more expensive than traditional business loans, although their approval ratings are higher and their applications processes are quicker. MCA is tailored to cover risks merchants incur when they invest in your business. The newer and riskier your business, the more money you will probably owe. In addition, there are no fixed interest rates on an MCA, so a merchant can ask for certain amounts at any time. Economic problems may prevent you from paying desired amounts, which will increase your debt and the time it takes to pay off the MCA. Don’t enter an MCA unless you are secure in what you can pay over a long period. Speak to a lender about each of your options, including traditional business loans, which may offer more security.

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