Small Business Tips
Beware: Merchant Advance Loans Could Hurt Your Small Businesses
If there’s one thing that all small businesses need in order to stay afloat it’s capital. That’s why, as past due bills start to pile up, entrepreneurs get desperate and seek out cash from wherever they can get it. In many cases his means turning to a short term merchant advance lender. Unfortunately, as Octavio Blanco of CNN Money recently highlighted, these types of loans could put a small business owner in an even worse financial spot than they were in before.
The way merchant advance loans work sounds fair enough: lenders give businesses a lump sum loan up front and are paid back by taking a portion of the business’s sales each day. In many cases this involves taking a cut of transactions processed using credit cards. The problem is that, in addition to paying back the principal amount owed, businesses are often charged steep premiums that could cripple their income. In fact CNN reports that the effective interest rates for such loans often reaches well into triple digits, even citing one entrepreneur who paid more than $37,500 over the course of 76 days for a $24,000 loan.
So what happens if you can’t make your daily payments on your merchant loan? Believe it or not some business owners will again turn to merchant advance loans in order to pay off their current loan. This cycle is sadly reminiscent of ones seen in the payday loan industry and can do about the same amount of financial damage as well. As a result many small businesses are forced to close when the cycle of debt spins too far out of control.
Of course there are two sides to every story and, while some entrepreneurs might regret their decision to borrow from merchant advance companies, others are thankful that they were able to get the capital they needed. For example Southern California business owner Joe Ruvacalba, says he once had five merchant advance loans out at one time because he was unable to obtain a bank loan. Even though he, in total, ended up paying more than $200,000 in interest and fees on top of the $500,000 in loans he ultimately took out, Ruvacalba said, “I’m not going to badmouth somebody that was willing to help me when the banks weren’t.”
This sentiment highlights a problem that, while improving, is still an issue for many entrepreneurs. Despite improvements in approval rates at big banks (the latest Biz2Credit report pegged approvals at 23.5% last month — up from 22.8% at the same point last year) the need for transparent small business loans still exists. Although in fairness, during the desperate panic that cash-strapped business owners might find themselves in, they may not take the time to stop and look at other options.
Ultimately merchant advance loans are unlikely to go away anytime soon. Although there may be better options for most entrepreneurs, including online lenders like, Lending Club and OnDeck, the sad truth is that some businesses may have to take such a risk as a last resort. In the end the best advice on the issue comes from Joe Ruvacalba who told CNN, “As an owner, you have to ask yourself: ‘Can I handle this payment every day?’ And if you can’t, don’t get it.”
