small business loans vs freight factoringBecause of the current situation with the economy due to the coronavirus pandemic, many small businesses are exploring their options with loans. While many reputable financial institutions are doing their best to help business owners, some loan providers are taking advantage of this situation with misleading loan options involving merchant cash advances (MCAs).

What Is a Merchant Cash Advance?

A merchant cash advance works by giving a business owner an upfront sum of cash in exchange for a portion of what’s generated from future sales. MCAs are paid back with daily or weekly payments plus fees until the original advance is fully paid off. MCA providers tend to target business owners with poor credit ratings looking for a quick and immediate source of cash to stay afloat.

What’s the Potential Problem with MCAs?

On the surface, a merchant cash advance sounds appealing, and it can be beneficial for some businesses. A percentage of revenue that comes in later is what’s used to determine repayment. The basic concept is that because the loan is based on a certain percentage of future earnings, the business owner would have less to repay if the business gets slow.

Yes, this is technically true. However, some small business owners have discovered the hard way that loan repayments, even if they are reasonable, can still far exceed the amount of cash that was advanced initially. Small business owners looking to keep up with repayments sometimes take out additional merchant cash advances, and this creates an ongoing cycle of dependence on loan providers.

What Do ‘Shady’ MCA Loan Providers Do?

Simply offering a merchant cash advance isn’t necessarily deceptive or questionable as long as the terms of the loan are clearly explained or disclosed. Unfortunately, some MCA providers don’t fully disclose terms or annual percentage rates (APRs).

Instead, not-so-reputable lenders may present terms that are confusing or purposely not clear, according to a Federal Trade Commission report concerning such loans. The report goes on to discuss how poorly informed loan recipients sometimes pay estimated annual percentage rates in the “triple digits,” which can certainly far exceed original loan amounts.

Are MCAs Really ‘Loans’?

A merchant cash advance isn’t technically a loan in the traditional sense. Some MCA providers have used this fact to their advantage to avoid adhering to standard loan guidelines and laws. MCAs actually fit into a category called factoring. This is an arrangement common in the trucking industry where owners receive immediate payment for invoices and the lender ultimately gets the payments from the invoices when they are submitted. You can learn more about freight factoring here on our website.

Again, there’s nothing inherently wrong with factoring or small business loans structured this way. The potential problem arises when certain bad actors are purposely unclear about percentage cuts and fees. Reputable and legitimate factoring companies, like the ones that serve the trucking industry, are usually honest about how such arrangements work and clear about related terms and conditions. The solution here is for small business owners to do their homework and look for reliable loan providers.