Speculation has recently been arising regarding the legality of a financial services product that many small business owners have been utilizing. Merchant cash advances are a loan on the anticipated receivables of the merchant’s credit sales. Scrutiny from financial news outlets and many banks has put the issue in the media spotlight. This article will explain more in depth what merchant cash advances are and explain their legal standing.
As explained, merchant cash advances are a popular product for many small businesses to borrow the funds they need to operate. By technicality, they’re not considered to be loans from a conventional standpoint. Since they’re based on a projected income and not credit, they’re not subjected to the same regulations as a bank or finance company would be. However, what does make them similar is that they’re subjected to similar financial information that a bank would review. This is one of the reasons that opponents are arguing that these are in fact, loans and should be subjected to banking regulations.
Small business owners are often attracted to merchant cash advances for many reasons. They offer much faster processing times and aren’t subjected to constant credit scrutiny. Many small business owners operate their business and personal finances as one. This means that the banks and finance companies often will deny them for anything but their initial loan to open their business. Since the underwriters can’t make any distinction between what’s actually considered a business account, a personal account, or both, they can’t make a favorable determination. Due to this cycle, businesses are unable to establish a business credit history that would be considered acceptable to these lenders.
Since credit isn’t a consideration with merchant cash advances, this doesn’t interfere with the process. As long as the business owner can provide documentation that their business has a reliable and strong receivables history, chances are they’ll be approved. Some banks will offer alternative products that will allow business owners to provide collateral; however, this often poses a problem as their initial business loan required collateral. The owner would have to either pay off their initial loan to provide collateral yet again, or they’d have to risk yet even more personal belongings.
Another thing that small business owners like about merchant cash advances is that they’re able to make small daily payments from their credit sales. The bulk of the loan can even be deferred to a later date where a balloon payment would become due. This is advantageous for businesses that count on seasonal increases in business. It’s also good for businesses that experience cyclical cash flow decreases. For newer businesses, the merchant cash advances have even more benefits to them. Underfunding is often experienced in the first few years of business. One emergency or unexpected expense could paralyze the business. Unfortunately, there aren’t many other options available to these business owners.
A major criticism of merchant cash advances is that they charge excessive amounts of interest and fees. Many business owners don’t seem deterred by these costs as the loans have grown in popularity significantly. However, what these opponents aren’t taking into consideration is that the banks themselves are charging excessive fees themselves. A single check is able to be presented multiple times to a bank. Should the item be returned, the bank is able to charge on the returned item multiple times. Also, banks are allowing customers to intentionally overdraft their accounts and offer it as a convenience service. This service also results in excessive fees and a cycle that’s difficult for business owners and individual consumers to break. However, the banks continue to provide the services and aren’t scrutinized because they’re not charging excessive interest but can justify the costs as bank fees that were intentionally incurred.
Operating under a much more transparent premise, merchant cash advances are a justified and perfectly legal service. It will be interesting to see if in the coming years the banks will continue to push for these services to be regulated. Perhaps the banks will offer a similar service or become more competitive in their offerings. American small business needs to survive just as the banks do. Unfortunately, they’ve not been able to receive bailouts for their cash flow problems as the major banking corporations have in recent history.