Merchant Cash Advance - The Wolf in Sheep's Clothing

TL;DR: A Merchant Cash Advance may look like a working capital lifeline, but hidden costs and aggressive repayment terms can turn it into a wolf in sheep's clothing. Before signing, understand the risks and explore alternatives like equipment refinancing, AR financing, or a business line of credit.

A Cautionary Tale

Once there was a small, young company that provided a necessary service to other companies. The company had good products, great customers, and a rapidly growing business.

They had an opportunity to take on a very large client, but they needed additional capital to make purchases, hire staff, and scale up quickly.

The owners met with their bank to discuss the opportunity and their capital needs, but the bank was reluctant to extend credit because the company was so young. The owner was disappointed and wondered how he could take on the additional business.

While driving back to the office, the owner heard a radio ad that offered small companies the ability to secure upwards of $100,000 in working capital simply by applying online. The owner memorized the web address and, when he returned to his office, visited it.

He entered the requested information, signed the online form, and almost immediately received a response stating the company had been approved. The next day, he checked the company bank account and saw the money had been deposited. He was thankful he could now take the next steps to expand his business.

A week later, his accountant told him that daily withdrawals were being made from the company's checking account, but the accountant couldn’t identify the payee because no vendor by that name appeared in the company’s accounts payable ledger.

The owner looked further into the company that had given him his “working capital” loan and discovered that the paperwork he signed during the online application process required daily withdrawals as loan payments. Upon further investigation, he discovered that the effective interest rate on the borrowed money was over 50%.

The working capital loan he had taken was a Merchant Cash Advance (MCA), a financing arrangement that can carry significantly different costs, repayment terms, and legal provisions than a conventional business loan. What he thought was a White Knight was really a wolf in sheep’s clothing, and it put his business in an even more precarious position.

How do you know if your working capital loan is really an MCA?

Companies that provide MCAs don’t use the term Merchant Cash Advance in their marketing. They dress up the language, using terms like working capital, “same-day business loans”, or “short-term financing”. They entice borrowers with phrases like: easy application process, no financial statements to submit, and funding in as little as 24 hours. Essentially, they disguise or gloss over the fine print, catching unwary borrowers off guard.

Most MCA companies press applicants to complete the application when the “application” is really the loan document – if it requires an electronic signature on a platform such as DocuSign (or equivalent), it is probably documentation committing you to their product.

If you closely read the documents before you sign them, you should look for the following keywords or phrases which indicate the loan is really a merchant cash advance:

• Confession of Judgment – when you sign this, you give up your right to a formal court hearing, and if you stop paying, the lender can bypass litigation and file a judgment directly with the court.
• Payback frequency – if automatic payment withdrawals are due daily or weekly
• Request for bank account information – routing numbers, etc.

We get it. When your business is struggling and you need capital to keep it afloat, quick, easy money can seem like salvation. In reality, the speed and convenience of an MCA can come at a high cost, and its daily or weekly repayment structure can put pressure on an already cash-strapped business.

But there are alternatives.

What are some alternatives to a Merchant Cash Advance?

Alternatives to MCAs can provide the working capital you need without the high cost and burden of frequent, automatic withdrawals. The right solution depends on why you need the money, what assets your business owns, the strength of your accounts receivable, your ability to repay, and how quickly you need the money.

Refinancing Equipment

If your business owns equipment, especially revenue-generating equipment that has equity, you could possibly refinance the equipment to get working capital. A knowledgeable equipment lender can assess your equipment’s value and structure loan terms to provide you with working capital.

Equipment refinancing won’t work in every situation. The lender will consider factors such as equipment age, condition, resale value, existing liens, and the company’s financial situation. But for a business with substantial equipment equity, it’s an option worth exploring.

Accounts Receivable (AR) Financing

If your company is a business-to-business company and issues invoices to other companies, accounts receivable financing could be an option.

Two common AR financing options include invoice factoring and asset-based loans (ABL).

With invoice factoring, a business sells eligible invoices to a factoring company, and the factoring company advances you a portion of the amount owed on the invoice. When the customer pays the invoice, the factoring company pays you the balance, less fees. Because financing is tied to the invoices, the creditworthiness of your customers is an important consideration.

An asset-based loan is a type of revolving line of credit. The credit line is based mainly on the AR, but other assets securing the loan can include equipment, inventory, and in some cases, real estate. As receivables are collected and new invoices are generated, the amount available to borrow changes accordingly.

For businesses with strong commercial customers, AR financing can be a good option to provide ongoing liquidity and cash flow.

Business Line of Credit

A traditional line of credit (LOC) can also help manage short-term and recurring working capital needs.

Unlike borrowing a lump sum, a revolving line lets a business draw funds as needed, repay them, and repeat the cycle up to the approved credit limit.

A line of credit from a bank will require more underwriting and documentation than other sources of working capital, and can take longer to obtain approval. But with time and planning, an LOC can align well with a company’s cash flow needs.

How do you get out from under a Merchant Cash Advance?

If you’ve already taken a merchant cash advance and daily or weekly withdrawals are straining your company’s cash flow, don’t make the problem worse by taking another MCA.

Taking a second advance to make payments on the first MCA, referred to as “stacking”, will compound an already difficult cash flow problem.

Start by reviewing your MCA agreement so you understand the payment requirements and payoff terms. Talk with your financial advisor or lender about whether there are opportunities to replace the MCA with financing that is better suited to your business.

Depending on your circumstances, possible solutions could include the alternative financing options discussed earlier in this article to get working capital to pay off the MCA – equipment refinancing, AR financing, line of credit.

If the MCA has already created significant financial or legal problems for the business, consult an accountant, financial advisor, or attorney who has experience with business debt and MCA agreements.

Moral of the Story:

If a working capital loan seems too easy or too good to be true, it’s probably a Merchant Cash Advance.

Before you sign anything, do some research on the company and read every line of the contract.

And don’t overlook the assets you already own. A business looking for $100,000 in working capital may think the alternatives are either a bank loan or an MCA. But if you own equipment, have substantial accounts receivable, or both, there may already be borrowing capacity hiding in your balance sheet.

The teams at Commercial Credit Group and Commercial Funding Inc. can help you evaluate options.

Watch our video on Alternatives to Merchant Cash Advance here.