As a small business owner, you likely need easy access to cash to cover unexpected expenses and seasonal lulls so your doors remain open and your customers stay happy. Banks and other financial institutions can provide you with this necessary capital in the form of loans, merchant cash advances, and business lines of credit.
But not all financial products are created equal. Informing yourself about the different options will help you maximize the financial benefits available while limiting your overall risk level.
Civilizations have placed limits on interest rates from the time of Hammurabi’s Code–the earliest known recorded laws in human history–all the way up to the early 1980s. Today, unscrupulous financial institutions offer merchant cash advances (MCAs) that come with excessive interest rates and hidden fees.
Many MCA plans carry annualized interest rates in the triple digits. And they often feature repayment schedules that can cause serious cash flow problems for your business.
The total cost of a merchant cash advance for business owners including all fees can lead you into a debt trap from which there may be no escape. It can become practically insurmountable to pay off a MCA without refinancing with another MCA before eventually filing for bankruptcy.
That’s why many financial advisors and consumer advocates consider MCAs a downright dangerous financing option for small business owners. These experts often describe MCAs as payday lending for small businesses, and strongly discourage their use due to excessive costs and potential for dependency.
Let’s take a closer look at MCAs so you can better understand their risks.
How do merchant cash advances work?
Here’s how a merchant cash advance plan works.The small business owner (or merchant) receives an a lump sum (or advance) of cash measured against expected profits. The merchant agrees to pay off the advance with a percentage of future sales.
Sounds pretty straightforward, right? Well, the devil’s in the details. Financial institutions claim that MCAs are not loans in order to avoid the scrutiny of federal regulators. This allows them to obscure the true costs and repayment structure of these agreements with a tangle of unfamiliar jargon including “specified percentage” (the percent you repay out of credit card sales), “purchase price” (the amount you receive) and “receipts purchased amount” (total payback amount).
MCA agreements frequently come with penalties for repaying what you owe early, and they often force you to take or leave arbitrary loan amounts that do not necessarily reflect the quantity of funding you actually need when you borrow. This means you can find yourself borrowing more than what you can use, which will cost you more to pay off in the long run.
Even worse, MCAs do not have listed annual percentage rates (APRs). With no listed APR, it’s impossible to know the true cost of borrowing, or to objectively compare an MCA with other types of loans or financial products.
The majority of MCA agreements structure repayments by having merchants remit fixed daily or weekly payments from the merchant’s bank account back to the lender. These remittance payments are known as Automated Clearing House (ACH) withdrawals.
Unlike with a traditional loan in which you owe one fixed payment every month over a set repayment period, with an ACH-style MCA you make daily or weekly payments, plus a raft of fees, until the advance is paid in full plus exorbitant interest.
An Alternative to MCAs: Business Lines of Credit
Fortunately, there is a better way to borrow to support the financial necessities of your growing small business. It’s called a business line of credit and it allows you to borrow and repay on an as-needed basis, making it ideal for short-term working capital needs.
Unlike an MCA, a business line of credit really is a simple and useful way to borrow. After submitting a short application form that contains details about your business and current financial position, you will be approved for the maximum loan available for a business of your size.
Once approved, you can choose how much you need to borrow up to the limit, and know that additional funding is there if and when you need it. As you continue to use the line of credit, you can also request to borrow additional funds as needed beyond the initial maximum.
There are two crucial differences that make a business line of credit much more beneficial than an MCA. First, there is never a penalty if you repay what you’ve borrowed early. In fact, you will actually receive a discounted rate for repaying in advance of when the loan comes due.
Second, you will only pay interest on funds you actually use. You don’t have to borrow the maximum, and can draw on the business line of the credit when it makes sense for your business rather than on the schedule of a loan officer hunting for bigger commissions.
Ultimately, a business line of credit gives you more flexibility in managing your finances. More flexibility means more freedom and a lower likelihood of dependency. You will be empowered to react to changes in the business environment as they occur. And that’s a recipe for success that anyone can understand.
Call Mulligan Funding at 855-326-3564 to discuss your financing options today!