Although the growth of our economy is regaining its momentum, big banks and traditional lenders are still slightly lacking in the area of small business lending. This has created a void and definite need in the small business world. To meet the need and fill the void, alternative lenders have popped up all over the place over the last decade, especially merchant cash advance lenders. They turned a $5 billion industry to a $50 billion dollar industry, according to the article “What Do Small Businesses Need Banks for, Anyway?”, (by Patrick Clark). Merchant cash advances can seem like a savior for many small businesses that are in need of fast capital and don’t immediately qualify for traditional bank financing. However, as a small business owner, it would be wise to do your due diligence before you dive in. Here’s the “Good, the Bad, and the Ugly” of the merchant cash advance world.
Merchant Cash Advances: The Good
Let’s face reality, many small business owners cannot qualify for traditional small business loans for several primary reasons:
- Their business lacks a track record – either no sales and revenue or very few sales and inconsistent revenue.
- Less than perfect credit – the owner’s credit history may have been damaged enough to ruin their credibility and drive their scores down.
Small businesses that fall into these categories will most likely be forced to seek alternative lending options to meet their capital needs. They are considered “high risk” to traditional banks and lenders and have near an impossible chance of getting approved through these avenues. Merchant cash advance lenders have taken advantage of this and will lend money to a small business where the owner lacks a good credit history or a certain amount of revenue. This can be very appealing to small business owners who are in a bind and need cash to grow quickly. However, you might want to think twice before you take the leap.
The Bad and The Ugly
Although merchant cash advances may seem easy to obtain. Buyer beware! This can be an extremely expensive financing option for a small business, especially if you are a startup. For example, a merchant cash advance lender lends you $50,000 and requires you to pay back $80,000. They would debit your bank account or take a percentage of your credit cards sales as a repayment, daily. The kicker is that you only have a short period of time to repay this money, usually up to 12 months only. It is a high priced, short term loan that can cause you to have cash flow issues if your business is not making a high volume of sales (or deposits) on a daily basis.
According to an article in the New York Times, “The Dangerous Appeal of Alternative Lending”, merchant cash advances can carry interest rates from 20% to 200%. That’s more than five times the traditional lending interest rate of about 4% to 6% (that can be paid back over a 25 year period). The interest rates of merchant cash advances can almost be compared with pay day loans, which are known to ruin people’s credit very often. It’s wise to either stay away from this type of financing (if you don’t have a high volume of daily credit cards sales or deposits) or use it only if it makes the absolute most sense for someone in your unique situation.