Drawbacks of Merchant Cash Advances

There are many perks to merchant cash advance services, however there are also many disadvantages that should be scrutinized. Small businesses should be aware of these potential setbacks in order to choose the best financing option for their purposes.

High Factor Rates

As a merchant cash advance is not considered a loan, it is not restricted by the same rules. Instead of applying an interest rate like loans, merchant cash advance providers will charge a factor rate, as the finance company is essentially purchasing parts of future credit transactions rather than loaning you the actual money. Although the factor rate may look reasonable at first glance, it becomes incredibly worrisome when you see how high the equivalent interest rate actually is. With rates that can reach triple digits, merchant cash advances might not be the best option for every business.

Service Fees

Unfortunately, the payments don’t stop there, as merchant cash advance companies also collect significant service fees. Although most companies will bill for the same things such as start-up, processing and payment fees, you’ll have to pay attention to the contracts, as these costs will vary from company to company. It’s important to take note of these details, as the high rates and fees attached can leave businesses worse off than they would have been initially. If the business is unable to meet the payments, then the merchant cash advance will send the remaining amount to collections, which will then damage the credit of the business.

Short-Term

While the length of a loan can take years, merchant cash advances have significantly shorter terms. Again, although it varies from company to company, typical terms run from four to eight months. As payments for the term are directly withdrawn from card sales, the more money borrowed will typically mean longer terms, albeit, it will still be shorter than that of a business loan.

Payment Methods

Although there are a few payment methods, merchant cash advances are in ways, far less flexible than loans. The most commonly practiced method is when the payments are directly withdrawn from card purchases as they are processed, while another method deposits card sales into a separate account before transferring funds to each respective party. Essentially, funds are withdrawn from each sale and returned to the financing company before they reach the business’s account, which could worsen cash flow issues.