Merchant cash advances (MCAs) are easy to obtain, but many business owners regret looking before they leap. This blog post lays out the key points to consider before signing on the dotted line. 

The enduring popularity of merchant cash advances (MCAs) is hardly surprising: they are one of the easiest and fastest sources of business cash. While 68% of small businesses were fully or partially approved for a bank loan, 91% qualified for an MCA, and that cash can arrive in as little as 24 hours. 

But Brian Holden warns that while MCAs can seem like an easy way out of financial distress for businesses, they are seldom as “easy” as they seem. As Chairman and CEO of AR Funding, he has worked with many small businesses that signed up for an MCA only to find themselves in far worse financial shape as a result. 

Interest rates of 695%

MCAs have been in the news lately because of the predatory and harmful behaviors of some lenders.

“We have seen an increase in businesses coming to us looking for a way to stabilize their business after taking out an MCA,” Holden said. “They needed quick cash, but the costs involved ended up being much higher than they expected.”

One of the most recent cases to cross Holden’s desk was an IT services company that had taken out MCAs with three financing companies. The annual interest rates varied from 39% to 225% to an astonishing 695%, and the accumulated interest and fees on an advance of $854,500.00 totaled $270,000.00. 

The company finally reached out to AR Funding looking for a way to pay off the MCAs and recover from this financial hit, and is now on track to clear its debt this year. But the impact of these costly MCAs came close to bankrupting the company.  

Strengthen your fundamentals

Businesses don’t take out MCAs because they’re affordable. They turn to this financing type as a last resort. Sometimes the situation is outside the business’s control, such as the pandemic or an economic downturn, but there are things every business owner can do to make sure they are in the best position possible to withstand financial knocks. 

• Improve your business credit score. An improved score gives your business better access to more affordable sources of financing.
• Be proactive around your accounts receivable. Staying on top of your AR helps you manage, predict, and optimize your cash flow.  
• Avoid nonpayment. A single unpaid invoice can deal a significant blow to the organization’s financial stability.
• Manage customer credit. Be intentional about the credit facility you extend to your customers.
• Improve your overall business resilience through insurance, diversification, and liquidity management.

Run your own numbers

Business owners don’t always realize that unlike banks, MCA companies don’t conduct due diligence to ensure the business is able to repay the advance, Holden said. 

“Because they earn a very high rate of interest, they can afford to write off a high proportion of debt,” he explained. “If your business goes under, they simply move on to the next contract.”  

This means that it’s important for the business to decide how much of an advance they need in order to remain solvent, rather than simply accepting the maximum amount the MCA company offers. Consult with your accountant, broker, or bank manager to determine the size of the advance you can afford before signing anything.  

Read the fine print

Holden has seen dozens of MCA contracts, so he knows they can be full of misleading language and confusing clauses. For example, many contracts define the advance as a “purchased amount” because this gives them more power to recoup their money in a court of law. 

Business owners should check the frequency with which payments are extracted from their accounts, because it can happen on a daily basis. They should also understand what happens in cases where a payment is missed. 

This happened to a staffing company that took out an MCA to fund a cash gap over the holidays, when billings are low and holiday pay creates an added expense. The MCA company collected funds daily and came up short in early January, which triggered an immediate lien. The lien allowed the MCA company to collect directly from the staffing company’s clients, which affected their reputation and invalidated the factoring arrangement they also had in place. 

“People don’t realize that if you miss one payment, the MCA company may have the right to call the whole loan, plus the full year of interest,” said Holden. “They also have the right to contact your creditors, including your customers, and collect from them directly.”

Read the reviews

Before committing to an MCA, check reputable review platforms such as the Better Business Bureau (BBB), Trustpilot.com, Google Reviews, and Facebook for any feedback from customers. Go beyond the numeric ratings and scan the text reviews for the deeper story about how the company treats its clients. 

Talk to the experts 

Businesses usually turn to MCAs when they need cash urgently. But fast cash doesn’t come cheap.

“When somebody tells you that you can borrow money within 24 hours and you don’t need to commit anything up front, it’s going to cause problems down the line,” Holden pointed out. 

Before signing a contract with an MCA, take a beat to explore alternatives. Even if it’s an emergency, you may have more options than you think. Call your accountant or financial advisor. Or talk to one of the factoring experts at AR Funding. Even if you’re not a client, our team can help you understand your options, discuss ways to improve your cash flow, and connect you to the financial experts in our network. Talk to an expert in your region today.