Why a Merchant Cash Advance Can Be Bad for Business

03/09/2016 12:12 pm ET Updated Dec 06, 2017


By Benjamin Pimentel

A merchant cash advance is a fast and easy way to get small-business financing. In fact, it may be too fast and easy. Rather than quickly opting for an MCA, you should pause to consider whether it's your best -- or only -- option.

An MCA is not a loan but an advance against future credit and debit card sales. You pay it back daily by sending a set percentage of that day's card sales directly to the lender. The annual percentage rate can range from 70% to 350%, much higher than small-business loans from banks or online lenders.

And if you're not careful, one merchant cash advance can lead to another and another, creating a debt spiral that can be hard to stop.

MCAs may be hard to pass up

MCA providers stress convenience and speed. CAN Capital calls the financing "cash-flow friendly": "You don't have to worry about fixed monthly payments during tough times, and there is no set maturity date."

Those flexible payments are attractive to some entrepreneurs.

"The cash advance traditionally fluctuates directly with the merchant's sales volumes," says Deborah Sweeney, CEO of MyCorporation.com, which helps entrepreneurs set up small businesses. "This gives a business owner flexibility with which to manage their cash flow, particularly during a slow season. When business is slow, the money withdrawn decreases, and increases during busier times."

David Goldin, president of the Small Business Finance Association, a trade association representing MCA providers, notes that unlike most traditional business loans, MCAs don't require personal guarantees.

"If you take a merchant cash advance and you owe $80,000 and your business goes out of business," Goldin says, "you owe the merchant cash advance provider nothing."

MCAs can begin to stack up

But the advantages, other experts say, are offset by a potentially huge risk: If you don't plan properly, an MCA could lead you into a debt trap.

An MCA might work as a "one-time thing to get through a rough patch," says Craig Everett, professor of finance at Pepperdine University's Graziadio School of Business and Management. "If it becomes an addiction, then it will eventually destroy the value of the business."

John Moore, professor of finance, economics and accounting at Walsh College in Michigan, calls merchant cash advances "expensive money."

"The entrepreneur should exhaust all its cheaper sources of financing first," Moore says.

If you're considering an MCA, Moore recommends consulting a financial professional and developing "a cash-flow forecast that demonstrates the business's ability to repay." If the analysis "cannot prove that the loan can be safely repaid within a reasonable time frame," he says, "the business should not take out the loan."

MCAs can chip away at a business's bottom line

Caitlin McShane of nonprofit lender Opportunity Fund echoes this point, warning that if a borrower isn't careful, an MCA could steadily erode a small business's cash flow and bottom line. In some cases, small-business borrowers take an MCA without completely understanding how it works.

"You can't figure out where the money's going," she says. "They pay themselves back before you see a dime from your own sales. Your revenue might even be up, but your profits are down."

Business owners caught in this trap may suddenly realize they can no longer make payroll or buy inventory, even though they "used to have a healthy cash flow to support" these needs, McShane says. And that's mainly because their profits are now going to make expensive debt payments.

"You find yourself borrowing more money to try to cover the first loan that you can't afford to repay and keep the lights on at your business," she says.

Benjamin Pimentel is a staff writer at NerdWallet, a personal finance website. Email: bpimentel@nerdwallet.com. Twitter: @benpimentel.

To get more information about funding options and compare them for your small business, visit NerdWallet's small-business loans page. For free, personalized answers to questions about financing your business, visit the Small Business section of NerdWallet's Ask an Advisor page.

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