Merchant Funding Can Get Your Business In Financial Trouble
If you have a business and credit isn’t easy to come by, you may end up turning to something called merchant funding, or merchant cash advances. These can seem like easy money—but the truth is that these kinds of loans can be dangerous and can lead you and your company into bankruptcy.
What is a Merchant Cash Advance?
With a merchant cash advance, a lender loans you money, the amount of which is set based on your predicted future sales or receivables. As you make money in the future, you pay off the money you borrowed.
This can seem like a benefit—because repayment is based on your future sales, there is no set repayment schedule. You don’t have to worry about making a loan payment if you had a down month of sales, and often the payments are based on what your business makes on a daily or weekly basis, again meaning that if you have a “dry spell,” or just a bad day financially, you won’t be left having to pay a loan payment you can’t afford.
Because these lenders are getting paid based on what you will make in the future, they are not concerned about your credit history the way a traditional lender would be.
Interest Can be High
But there are hidden drawbacks to this kind of loan. The first is the amount of information about your business you will give these lenders. The lender will typically require access to all your bank accounts—or require you to open a new, joint bank account with them—allowing them to withdraw whatever money they are entitled to.
The other problem is repayment—the amount of your daily or weekly receivables that you will pay when calculated will often come to a much higher interest rate than you’d pay on a traditional loan. In fact, if it were considered interest on a loan, the amount you repay may even be considered usurious.
And because the lender has full access to your accounts, they will withdraw the money, no questions asked.
That means that every day, at the end of the day (or week), you will have made less than what you brought in—the “loan” repayment amount will be gone before you even see the deposits. Contrast this to a traditional loan, which is usually paid every 30 days, giving you some time to plan or save money. You can easily run into cash flow situations with your business having money withdrawn so frequently, which can lead to even more financial problems.
Invoice factoring is slightly different. This is where a lender pays you before your client has to pay you. This allows you to get money immediately and not have to worry about slower paying customers. Often the factoring company will assume the risk of your customer not paying.
Like merchant receivables funding, invoice factoring can create problems in that the amount that the company takes as interest can make a large dent into what you are paid.
The good news is that bankruptcy will stop any withdrawals from these companies, all collection activities, and will wipe out anything owed to these companies.