8 Reasons Restaurant Owners Should Avoid Cash Advance Programs
You see advertisements for them everywhere: fast approval, bad credit OK, no docs no collateral – no hassle… Business cash advance and merchant cash advance loans are the hottest trend in finance, but are they the best solution to your cash flow problems?
Here are the top 8 reasons every smart business owner should avoid business cash advance programs:
- The Cost.
If you’re looking for cash to build your business without the hassle of going through the bank underwriting process, then the promise of fast approval, no documentation, no collateral, and overnight funding may sound like the perfect solution.
The truth is the only ones making any money with a business cash advance are the lenders selling them.
Let’s take a look at one of the larger cash advance lenders, OnDeck. OnDeck offers loans from $5,000 to $25,000, with loan terms ranging from three months to two years.
To simplify, let's look at their first example from this chart taken directly from OnDeck's website. It's a $25,000 loan with a 6 month repayment term. So, what's the interest rate on this loan?
You may think: this $25,000 is going to cost me $4,250 to borrow (which is equivalent to a 17% of every dollar borrowed), but you’d be wrong.
You also need to add in the 2.5% loan origination fee. 2.5% of $25k is $625 and brings the total cost of the loan to $4,875. So the interest rate would be 19.5% ($4,875 divided by the principal amount of $25k), right? Wrong again!
You need to understand that interest rates are not just determined by dollar amounts, but also by calendar days.
How quickly you have to repay the loan has a significant impact on the real cost of the loan. The quicker you pay off the loan, the higher the interest rate. Likewise, more frequent payments add to the cost of the loan.
Because your cash advance repayment is withdrawn daily directly from either your credit card processor or your business bank account, cash advances are among the most expensive funding options available.
Your effective rate, which is the mathematically true interest rate, is 108%!
- You Have To Start Making Payment As Soon As You Borrow It.
Let’s assume that you got a merchant cash advance for $100,000 that requires a payback of $120,000 in six months.
Assume that the payback is in equal installments, which is not always the case. By the third month, you will have repaid $60,000, which leaves you with only $40,000 in availability ($100,000 original line – $60,000 in payments = $40,000).
Compare that to a $100,000 line of credit. You get the entire $100,000 to use the entire term.
- It Ties Up Your Cash Flow
Unlike a line of credit or business loan where you can make monthly payments, a cash advance typically requires daily repayment either through your credit card processing or direct from your bank account.
The payment amount is typically 10-25% of your daily transactions, which for most businesses is their daily profit.
You literally have zero control over your repayment. What if a windfall once in a lifetime opportunity lands in your lap? Your hands will be tied until your advance is repaid.
- You Have Greater Exposure To Default
The premise of a cash advance is that you are selling future sales. This premise can be a problem for some businesses because the future is hard to predict.
The problem is compounded because the repayment is withdrawn daily.
Imagine a client’s check bounces just as you place a large order to restock your inventory. You’ll have no profit margin to protect yourself from the avalanche of overdrafts about to swallow your business.
- You Have To Give A Personal Guarantee
Should you default; the lender can come after your home and personal assets.
Any business funding program that requires your personal guarantee should be given a hard second look.
A business should be designed to provide you and your family with a secure financial future.
Any business that requires you to risk your home and assets to secure funds to cover your daily operating expenses might not be a business worth saving.
- There Is No Business Credit Building Benefit
Many business owners will take a cash advance in the hopes of building their business credit. This is a mistake.
When you receive a cash advance, the lender will notify the credit bureaus through a UCC filing, which will appear on your business credit report. A UCC-1 financing statement, an abbreviation for Uniform Commercial Code-1, is a legal form that a creditor files to give notice that it has or may have an interest in the personal property of a debtor.
The form is only filed to provide public notice that the vendor is first in line to claim the your assets for repayment should you default. A UCC filing will not benefit your credit score in any way.
- You Give Up Control Of Your Business
When you set up your contract for a business cash advance, it will list a number of contingencies that you need to follow. Vendors require these contingencies to make sure they get their money back. However, these rules can also restrict how you do business.
All merchant cash advance contracts will require that you don’t interfere with credit card sales in anyway. For example, you can’t start giving a discount to customers that pay with cash. They may also require you to change credit card processors to one with less favorable interest rates and fees.
Your contract may also bar you from changing locations, taking out a business loan, or closing your store for a significant amount of time. If you break any of these rules, you could be sued for breaching your contract.
- It’s An Unregulated Industry
This segment of the lending industry is not regulated because it’s technically an advance, and not a loan, and your repayment terms are tied to future credit card sales.
This lack of regulation has led to some unscrupulous practices including companies advancing more money than a business has capacity to repay and cases where the cash advance company changed its billing practices without notifying the merchant borrowers.
In conclusion, while cash advance programs may provide overnight funds with little documentation, they also carry a heavy cost, lots of risk, and minimal upside potential.
At loansforsuccess.com, we work with small business owners to access over 2000 lending programs, many of which require no personal credit check or assets for collateral…. Most of which have much better pricing and more favorable terms.
Before you make your deal with the devil, and sign away your future profits for the promise of cash today, do yourself a favor and let us help you discover all your options.
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