Alternative funding can be the safety net for a business in a tight spot, but it can also be the worst bane of your existence–and the beginning of a debt cycle. A Merchant Cash Advance is common among phony alternative lenders looking to rip off needy small business owners.
Unlike traditional loans, these products feature painless applications and instant funding (in as soon as 24 hours). It’s no wonder most entrepreneurs rush to accept these offers even before reading the fine print.
What’s a Merchant Cash Advance?
A merchant cash advance is a short-term loan that allows businesses to access cash quickly. Businesses can use the money to pay down debt, cover expenses, or invest in growth opportunities. The borrowed amount (plus interest) is repaid from future credit card sales – usually within 3-6 months – and the business keeps the rest of the credit card revenues.
But with so many companies offering this kind of financing product, how do you know which one is right for your company? And what are the red flags to look out for when choosing an MCA provider?
The Red Flags to Watch When Taking Out an MCA
You may suffer exorbitant APRs
Unlike traditional loans, MCAs are not regulated by the government. In essence, they do not fall under standard loans, meaning there are no limits on interest rates.
Your average sales, MCA fees, and how long you take to repay determines the APR. This explains why some of these loans have extremely high APRs.
You wind up in a debt cycle
MCAs can easily trap you in a debt cycle. Because these products are expensive, you can be tempted to take out another one in an effort to pay off the previous debt. This approach can hinder cash flow and compromise your ability to pay bills.
Confusing contract terms
Many merchants find themselves trapped in some sort of contractual obligations with the lender as they fail to understand what they have signed up for. Furthermore, most MCA providers won’t reveal APRs making it difficult to work out the real cost of the cash advance.
You may not know it, but the consequences of an MCA may follow you throughout your life as a business owner. That’s because MCAs are perpetual debt obligations, which means that they only end when the business is sold or goes bankrupt. Entrepreneurs must be extremely careful when using this product.