Merchant Cash Advances: The devil is in the details

MerchantCashAdvancesOne of Inspira’s clients, Voto Health, needed to be certified as a Medicare provider in the state of Washington. That process took much longer than expected and Voto found itself in need of capital. It turned to a merchant cash advance, thinking it would be similar to a loan or line of credit. Voto found out, much to its chagrin, that a cash advance was something far worse.

Like a payday loan for your business

A merchant cash advance is not a loan in the way that a traditional business loan is. Nor is it factoring, where a third-party takes ownership of your accounts receivable. Merchant cash advances are a very different kind of obligation. In exchange for cash today, a business pledges a specific dollar amount of its future earnings. Think of a merchant cash advance as a payday loan for your business.

Just like with payday lenders, you specify how much money you want to borrow, and the payday lender tells you how much money you will need to pay back. In this case, a merchant cash advance company tells you what your “factor” is. They multiply the amount you want to borrow by that factor. If the factor is 1.4 and you want to borrow $100,000, you repay them $140,000.

Next, a merchant cash advance services tells you how much of your future payments you must give to them and for how long. This varies, but the faster you pay off the obligation the less cash you will have on hand. If you give them 25% of your future receipts, it will take less time to repay them than if you paid 10%.

The upside of a merchant cash advance is that you get money fast, usually with no collateral. Another benefit is your repayment depends on your receipts. If you are in a slow payment period for your business, you still will pay them the same percent of your incoming payments, but the dollar amount will be lower.

The many downsides of a cash advance

The federal government warns consumers, “A payday loan or cash advance loan can be very expensive. Before you get one of these loans, consider other ways to borrow.” The same should be said for businesses thinking about a cash advance.

The downsides to a merchant cash advance can be surprising. The first is that usually a funder requires payment every day. Yes, you read that correctly – every single day. If you want to avoid the hassle of paying them daily, you can give them access to your bank account. They will then take the payment for you automatically with no involvement on your part.

Another surprising negative to a cash advance is the length of repayment. Unlike a loan which takes years to pay off, typically an advance is paid off within months. Although a rapid payback may seem like a good thing, it actually means the effective interest rate of a cash advance is much higher than with a traditional loan. In the earlier example, if a company promises to pay $140,000 and it takes 8 months, the company doesn’t pay a 40% interest rate. On an annual basis, it pays 60%.

A line of credit ends the vicious cycle

Voto Health found itself in a vicious cycle of paying off a merchant cash advance on a daily basis. This reduced their operating capital, which meant they had to borrow more to stay in business. The process repeated until finally Voto found Inspira.

Voto Health’s CEO recounts, “We had to use daily advance companies, people who advance you money and you pay 30-40% interest on what they give you. It’s very expensive.”

Inspira gave Voto a line of credit, allowing them to pay off their merchant cash advances and finally gain the breathing space they needed.

“What Inspira did was they gave us a loan and we paid off the advances,” Voto’s CEO explained. “Now we have a normal monthly payment. We are improving and expanding and doing very well. Our cash flow increased and our profitability increased. We expanded into different areas we wanted to be in, like Seattle.”

Inspira offers revolving lines of credit (RLOC) exclusively to physicians, medical offices, hospitals and healthcare agencies. Find out how Inspira can help your healthcare business.