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The Dangers of Merchant Cash Advances for Small Businesses

 

Payday lenders have faced intense scrutiny over the last decade for their predatory and aggressive lending practices.  Payday lenders, such as Kwik Kash, Money Mutual, and Speedy Cash, provide loans to vulnerable consumers facing financial hardship.  While these loans may provide the short-term relief sought after, quickly these loans trap many of these consumers in a cycle of debt.[1]  Payday lenders typically charge 400% APR or more on their loans, so consumers often end up paying hundreds in interest on fairly small loans.[2]  Thus, what once looked like a lifesaver to many of these consumers becomes a very large financial burden in itself.  Because payday lenders are so common and popular for consumers facing financial emergencies, the effects of their exploitative business strategies are far reaching.

While a majority of the recent outrage over fast cash loans has focused on the payday loan industry’s harm to individual consumers, the merchant cash advance (MCA) industry’s deleterious effects on small businesses should not be underestimated or overlooked.  MCAs can be applied for online, don’t have stringent credit requirements, and can often be received the same day.  All of these factors make them a very popular financing option for small businesses in search of capital.  These loans work in much the same way that payday loans do; they too carry exorbitantly high interest rates and contain many hidden fees.  These terms make it nearly impossible for these already cash-strapped businesses to pay back their loans on time.  Thus, many of these businesses seek out additional loans to pay off their existing debts and get trapped in the same cycle of debt that payday loan consumers find themselves in.  MCA lenders also often require their customers to sign Confessions of Judgments, which leave their customers without legal recourse when they want to dispute a claim.[3]

The problems created by this industry will become particularly acute as more small business owners face financial distress as a result of the COVID pandemic.  Small businesses often lack the capital necessary to handle long-term unexpected slowdowns or shutdowns of their operations.  As a result of COVID shutdowns, many small businesses have had to figure out ways to cover their normal overheads with severely reduced income streams.  Because it often takes weeks to be approved for traditional bank loans and other sources of funding, like grants, are especially competitive right now, many small businesses are turning to quickly obtainable and easily accessible MCAs.  The effects of the pandemic on these small businesses will extend far beyond the COVID shutdowns as they struggle to get out of the quick cash cycle of debt and pay the large interest payments on these loans.

[4]

Unfortunately, there isn’t much oversight of this industry.  MCAs work differently than other loans, allowing MCA lenders to evade regulations that would otherwise protect their customers.  MCA lenders provide cash to their customers in exchange for a cut of their customers’ future credit card sales.  As such, unlike traditional lenders, they aren’t providing cash in exchange for a promise to be paid back.  Because of this, MCA lenders aren’t subject to usury laws or the Truth in Lending Act and can get away with charging high rates and fees on their loans.[5]  While the Federal Trade Commission (FTC) has recently sued several MCA providers for making misleading statements about the terms of their MCAs to customers, there is still very little protection for small businesses in this industry.[6]

Seeing as regulations aren’t in place to protect small business owners from these predatory lending practices, small business owners must educate themselves about these loans and seek alternative funding solutions.  These loans are notoriously difficult to understand, as interest rates aren’t annualized, timelines are muddled, and many terms are hidden in the fine print.  Thus, businesses that are considering MCAs should carefully consider what the short-term relief of an MCA will cost them in the long-run.  Luckily, there are several alternatives for small businesses seeking capital.  Businesses considering MCAs should instead consider short- or long-term bank loans or lines of credit, SBA loans, and asset backed loans.  These other options, while harder to obtain, will provide necessary financial relief without sacrificing the business’s long-term prospects and financial health.

By Gabriela Hindera


[1] How Payday Loans Work, In Charge Debt Solutions,  https://www.incharge.org/debt-relief/how-payday-loans-work (last visited March 1, 2021).

[2] How Payday Loans Work, Payday Loan Consumer Information, https://paydayloaninfo.org/facts (last visited March 1, 2021).

[3] The Ugly Truth About Merchant Cash Advances, Opportunity Fund, https://www.opportunityfund.org/the-ugly-truth-about-merchant-cash-advances (last visited March 1, 2021).

[4] https://www.austinmonitor.com/stories/2017/05/judge-rejects-citys-payday-lender-rules/

[5] Merchant Cash Advance Regulation: Does It Exist? What You Need to Know, Fundera, https://www.fundera.com/business-loans/guides/merchant-cash-advance-regulation (last visited March 1, 2021).

[6] Protecting Small Businesses Seeking Financing During the Pandemic, Federal Trade Commission, https://www.ftc.gov/news-events/blogs/business-blog/2020/08/protecting-small-businesses-seeking-financing-during (last visited March 1, 2021).

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