There’s a new alternative to conventional loans that’s become popular with small business owners in recent years. Known as merchant cash advances, the products offer fast funding without the need to have good or established business credit. The popularity of this option has also drawn some questions regarding the legality of these advances. The concern over whether or not they need to be regulated as banking products has people in the financial industry and small business owners raising concerns. Many business owners and even finance professionals question if anything is actually illegal about these convenience products. This article will give a high-level overview of the workings of merchant cash advances and whether or not their legality is worthy of questioning.
Bad credit Merchant cash advances are sometimes also referred to as merchant credit advances. These products are a relatively new concept that’s very similar to invoice factoring or funding. Both use a receivables balance as a basis of determining approval and a loan amount. They also both have fast processing and underwriting times. Also, the business’s credit isn’t much, if at all, a consideration when determining approval. The financial performance of the business, its sales forecasts, and receivables history are what’s used as the primary basis of a determination. The companies are obviously required to have a relatively stable history and length of time in business. This makes many people wonder why these companies simply wouldn’t opt for a traditional bank loan or a business line of credit.
Small business owners are notorious for combining their personal and business finances. When the business is a sole proprietorship, this makes sense for many business owners despite the common advice that’s given to them. Consequently, businesses often fail to establish a solid credit record of their own. Often times, a business owner will use their own credit cards, bank accounts, and other methods of payment for the business’s expenses. This is especially true when there’s an emergency or urgent need for funds. The cycle continues until the owner has nothing else left. This leaves them in a serious bind and can even lead to a business’s closure. Also, many business owners end up using their personal effects as collateral or to fund the business. This also continues the cycle of not being able to borrow conventionally like a larger sized business.
The merchant cash advance option alleviates their concerns and allows them to borrow the money they need to keep their business open. They also appreciate not having to put up additional collateral to secure the loan. For the convenience factor, the merchant cash advance companies charge a premium that includes interest and fees. The business owner is able to deflect the payments until a later period. They are required to have a small amount deducted each day from their credit sales. This is mutually beneficial to help reduce the balance for the business owner and the advance company receives some form of initial repayment. When the balloon payment becomes due, the owner has typically had enough time to repay the advance company.
Banks and finance companies are unable to provide a similar service except for allowing them to overdraft their accounts. One could argue that this would similarly be a service that should be subjected to banking regulations. The banks aren’t penalized for not charging interest or for considering it a loan because they’re not actually lending based on credit. However, the bank is well aware of the account owner’s credit history at the time of account opening and offers this as an optional service at the same time.
Since merchant cash advances are certainly legal, they will probably be around for some time to come. It will be interesting to see if banks come up with a similar service that they begin offering to their commercial account holders. This may also give banks and finance companies the cue that they should probably come up with more convenience services for small business owners. If nothing else, it would be wise for these companies to come up with additional products that are accessible by the average small business owner. The regulation of merchant cash advances is still up in the air. Whether or not these services will ever be subjected to conventional banking regulation will remain a mystery for the time being.