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Merchant Cash Advance Regulation: Does It Exist?

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Some outside funding is likely to come into every small business owner’s life. According to the National Small Business Association, 69 percent of small businesses used financing in 2017.

For some businesses, easy and quick funding sounds appealing. But in the financial world, the easier and quicker is it to get funding, the more expensive it tends to be. One type of funding that has fairly low requirements in comparison to others is a merchant cash advance.

You can typically apply for a merchant cash advance online, get cash the same day or at least in 48 hours and not have to fill out a ton of paperwork. Sound too good to be true? Well, in some cases, yes. Merchant cash advances are also one of the most costly funding options, said Gerri Detweiler, credit expert and educator director at Nav, a company that helps business owners access funding and make informed financial decisions. That’s doesn’t mean, however, that there’s never a situation in which an MCA might work for you.

What is a merchant cash advance?

The first thing to know about a merchant cash advance is that it isn’t technically a loan; instead, it represents a purchase of your advanced sales. Simply put, it allows you to sell your future credit card and debit sales to a merchant cash advance company in exchange for a lump sum of cash upfront. You repay the advance by letting the company take a portion of your daily — or sometimes weekly — credit and debit sales over a short period of time, typically less than 24 months, until you’ve paid it off, according to Detweiler.

Merchant cash advance companies don’t use APRs to charge interest, they use something called a factor rate. Factor rates usually range between 1.2 and 1.5. You can figure out your APR, however, which can range from 70 percent to 200 percent. In other words, merchant cash advances are very, very expensive, so be very careful if you’re thinking about one.

One scenario in which a merchant cash advance might make sense is if you see a big benefit from getting fast cash  — for example, perhaps you can buy inventory at a steep discount — and you have the strong sales to repay the advance.

If you don’t need quick cash and you have good credit you’ll have a lot more funding options to consider — and plenty that aren’t nearly as pricey. Unlike many loans, however, you don’t need good personal credit to get approved for a merchant cash advance, Detweiler said. Most traditional lenders — banks and credit unions — require a 680 credit score or higher to issue a loan, and online lenders will generally go as low as 620 or 600.

You could get a merchant cash advance, though, with a credit score below 600 (which falls into the poor range), depending on your business sales, Detweiler said. Merchant cash advances can also be easier for startup businesses, — which often have a hard time getting funding — to get. “They’re not that interested in personal credit. They’re really looking at how much revenue your business is bringing in,” she said.

How do MCAs work?

You typically apply for a merchant cash advance online, and you can expect to submit your credit card and possibly your bank statements when you apply.

If you’re approved for a merchant cash advance, you’ll be given a factor rate, usually from 1.2 to 1.5. The more evidence that points to you being able to repay the advance, the better the factor rate you’ll get. Like an APR, the factor rate determines how much you will have to pay back. If you borrowed $15,000 and your factor rate is 1.3, you multiply the two to figure out how much you have to pay back, which in this case would be $19,500.

But because you have to repay the advance quickly, the amount you’re really paying is a lot more than it seems. For example, let’s go back to that $15,000 you borrowed — with the factor rate, you must pay back $19,500. If the merchant cash advance company takes 15 percent a day from your credit sales to repay the advance and you usually make about $10,000 a month in credit sales, you’ll end up make 390 payments of $50 a day, for an APR that equals 51.3 percent.

Look out for these features

If you have poor personal credit, own a startup business or need money to take advantage of an opportunity or take care of an emergency, merchant cash advances might be your best option. But proceed with caution.

“They can be helpful for someone who doesn’t have those traditional loan qualifications (credit score, time in business and annual revenue). They’re really aimed at someone who needs cash really fast and has the sales to land that financing quickly,” Detweiler said.

But there’s plenty to watch out for, too, particularly because merchant cash advances don’t fall under federal regulatory oversight and are not subject to state usury laws because they’re not classified as small business loans. Here are some things you need to consider with a merchant cash advance:

Mega APR rates. Even if you’re given a factor rate on the lower end of the range, depending on the amount you borrowed, how much you make in credit sales and what percentage the merchant cash advance company is taking, your actual APR rate could be extremely high. If you know your numbers, you can plug them into a merchant cash advance calculator to figure out your APR.

Debt stacking. If you’ve entered into a merchant cash advance agreement where the company will take a fixed amount out of your sales regardless of how much you’re selling, you might have to take out another advance just to keep up with the first one. Accepting multiple loans or advances at the same time is called debt stacking. “That can really put you in a precarious position where you have to go back to the well and you’re piling debt upon debt,” Detweiler said.

Daily payments. Keep in mind that you’re going to be responsible for paying back the advance every day. Some merchant cash advances are structured so that you owe the same amount each day, regardless of your sales, Detweiler said. Can you afford to make those payments even if your sales drop? Some merchant cash advance companies, however, will structure the advance so that they take a different percentage of your sales as they go up or down.

Merchant cash advance regulation

Because merchant cash advances aren’t considered loans — they are considered purchases — there really isn’t any regulation associated with them.

Merchant cash advance companies don’t need to follow state usury laws, which limit how much interest companies can charge on certain loans or credit cards, Detweiler said. When it comes to credit cards, however, companies are allowed to charge the highest level of interest allowed in the state in which they’re incorporated, versus the state where the customer lives. That’s why so many credit card companies incorporate in states like Delaware and South Dakota, where limits on credit card interest rates mostly don’t exist.

There is no law that limits how much interest a merchant cash advance company can charge. The one type of regulation these companies fall under is from the Uniform Commercial Code. The code helps regulate business transactions in a uniform way, in particular for businesses that borrow money, lease equipment and sell goods in multiple states. But that code doesn’t regulate interest rates.

Will there ever be merchant cash advance regulation? Yes and no, Detweiler said. It’s unlikely merchant cash advance interest rates will be regulated, but some states are beginning to look at legislation around more transparency.

California, for example, has introduced bill SB 1235, which passed an assembly committee in July but still needs to go before the full senate. The bill would require providers of commercial loans, credit plans and accounts receivable purchasers (including merchant cash advance providers) to give business owners the total amount of funds they will be responsible for, including all fees and charges. It doesn’t, however, limit how much interest they can charge.

“This is the very, very first step in providing more transparency to small business owners when they need funding,” Detweiler said.

At the moment, the Consumer Financial Protection Bureau doesn’t have the authority to regulate commercial lending or factoring, although it can require certain lenders to collect borrower demographic information per the Dodd-Frank Act. The Federal Trade Commission, meanwhile, is involved primarily with making sure providers don’t mischaracterize their products or engage in deceptive practices.

With the potential of more oversight coming one day, some online lenders are trying to get out in front of it by offering some types of self-regulation. For example, the Innovative Lending Platform Association is a trade organization focused on best practices and standards in the industry. There’s also the Responsible Business Lending Coalition’s Small Business Borrowers’ Bill of Rights.

The bottom line

Because it’s unlikely that merchant cash advance interest rates will be regulated anytime soon — at least at the federal level — it’s up to you as the business owner to do your due diligence.

First and foremost, know your margins, Detweiler said. “If you don’t intimately understand your business financials, get a second opinion from a trusted financial adviser before you do anything,” she said.

And make sure a merchant cash advance is the right type of funding for you. Can you qualify for other loans or funding with better interest rates? Is this really an emergency?

“If you own a restaurant and the fridge breaks down, and it’s full of seafood, then yes, you probably need it right away,” Detweiler said. “Otherwise, a line of credit, or even a high-limit credit card, could be a fast and easy alternative.”

In addition, make sure you know what a merchant cash advance will really cost. What are the fees? Will you pay back the advance with a fixed amount of your sales or will your payments be based on a percentage of your sales? Last, but not least, always convert your factor rate into an APR. “The No. 1 thing you really want to ask is, ‘Can I afford to pay this back?’” Detweiler said.


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