As Cory Elliott’s construction business boomed, her debt woes began. She had been turned down by 10 banks for financing to expand her St. Louis construction business, and a financial consultant she hired suggested a popular alternative: a merchant cash advance.
Six months later, she was paying over $14,000 a month to service debt of $130,000 for two cash advances. If you’re thinking this sounds like payday loans for small businesses, as some critics have called merchant cash advances, you’d be on the right track. Both consumer payday loans and merchant cash advances can sink borrowers into a debt spiral of high-interest, short-term loans, small-business advocates say.
Merchant cash advances — a form of online small-business lending — are marketed as a way to help businesses invest in their future. But some small-business owners say this cash brought them to the brink of ruin.
“I’m not dumb,” Elliott says. “I felt so taken advantage of.”
Across the country, nonprofit organizations that help small businesses refinance debt have seen a wave of entrepreneurs like Elliott ask for help after getting merchant cash advances, which can have triple-digit annual percentage rates as high as 350%, according to several studies.
A March report by the Federal Reserve found that 7% of small-business owners in a 26-state region applied for a merchant cash advance last year. In Florida, for example, that figure is 18%, or nearly 1 in 5 small businesses.
“We see echoes of the early days of the subprime mortgage boom” in the rise of online small-business lending, Gerron Levi, director of policy at the microlender National Community Reinvestment Coalition, said in a hearing by a U.S. House subcommittee in July. Later this year, lawmakers in Illinois may tackle these concerns when they consider the nation’s strictest rules on merchant cash advances and other online lending.
For now, however, it’s buyer beware. Here’s what business owners need to know before taking a merchant cash advance:
A ‘loan’ that’s not a loan
The merchant cash advance revolutionized small-business financing by seeing future credit card or debit sales as a product that could be sold at a deep discount — like a car valued at $50,000 and purchased at the cut-rate price of $35,000. The financing company gives the $35,000 upfront; in return, the small business agrees to pay back the full $50,000 within months.
While bank loan applications often require mountains of paperwork and weeks of effort for an uncertain result, a merchant cash advance can provide money within days for businesses with poor credit or a short track record. And collateral and personal guarantees aren’t required.
“It’s really more like a mini venture capital investment in a Main Street business,” says Parris Sanz, the chief legal officer at CAN Capital, which pioneered the merchant cash advance trade.
Since it’s not technically a loan, cash advances fall outside lending laws. Comparison shopping among merchant cash advance offers is difficult, since terms can vary widely, and practices banned in other forms of lending — including hidden fees and not disclosing the annual percentage rate — are rife, small-business advocates say.
‘Vultures’ picking at you
Unlike other forms of financing, merchant cash advances require daily or weekly remittances — a repayment schedule that can kill cash flow, some business owners say.
“It was like these vultures kind of picking at you,” says Len Rogers, owner of the Electric Bicycle Super Store in San Francisco, who got two advances totaling $72,000, requiring weekly repayments of nearly $1,800. “They were just getting their beakful of meat every week.”
Originally, cash advance repayments ebbed with debit or credit card sales: If the business made more, it paid more; but if sales were down, the payment fell. Now, the majority of merchant cash advance transactions are direct, fixed periodic debits from the entrepreneur’s bank account, says Sean Murray, a former merchant cash advance broker who founded the trade magazine deBanked.
Businesses that agree to direct bank transfers are having a harder time, says Gwendy Brown, vice president for research and policy for microlender Opportunity Fund in San Francisco. “There’s no wiggle room — if sales are slow, you still pay the same amount.”
Brokers get big commissions
One thing that should be top of mind when being pitched a merchant cash advance offer: The person selling the deal may take a 10% cut or more of the amount borrowed.
Brokering a $20,000 advance can earn a $2,200 commission, says James Shepherd of CC Sales Pro, which trains independent brokers and earns referral fees for merchant cash advance sales with National Funding, a lender based in San Diego. “I always tell business owners, ‘Don’t get a merchant cash advance to solve your problems; get a cash advance to take advantage of opportunities,’” Shepherd says.
For example, a pizza shop owner’s oven was destroyed in a fire. While the owner was waiting for a $30,000 check from his insurance company, he found a used oven for $15,000 and took out a merchant cash advance to pay for it. “So he knew that money was coming, and he could get his business up and running faster,” Shepherd says. “If you get a merchant cash advance to solve problems — like cash flow or making payroll — you’re only throwing fuel on the fire.”