How Merchant Cash Advances Work

Small-business owners who need quick access to capital have a burgeoning industry eager to fund them: merchant cash advance providers. The decade-old industry has grown significantly in the past two years, to more than 50 providers, observers say, and the tight credit environment is fueling demand. As interest in their business grows, providers—who charge premiums of 30% or more on the money they advance—are trying to promote industry standards to avoid scrutiny from regulators.

Cash advance providers offer businesses a lump sum payment in exchange for a share of future sales. They mostly target retail, restaurant, and service companies that have strong credit-card sales but don't qualify for loans because they have bad credit or little or no collateral. The catch for takers is how much cash advances cost compared with interest on a loan or credit line. The equivalent interest rates can range from 60% to 200% APR, according to Leonard C. Wright, a San Diego accountant and "Money Doctor" columnist for the American Institute of CPAs. He says that may be acceptable for companies with no other options, but business owners need to treat the advance like a loan and understand what the costs are.

Merchant cash advance companies take pains to point out that advances are not loans; instead, the deal is a "purchase and sale of future income." That means that merchant cash advances are not bound by laws that regulate lenders and limit interest rates. Instead of requiring regular fixed payments, they directly collect a set percentage out of a merchant's daily credit card sales until they recover the advance and their premium, usually in fewer than 12 months. Advance providers say businesses benefit because the amount they pay varies with their cash flow, so they pay less in slower months. "When a business takes a loan, they have a firm date that it has to be repaid; they have fixed payments that have to be made on a schedule," says Mark Lorimer, chief marketing officer of Kennesaw (Ga.)-based AdvanceMe, which pioneered the industry in 1998. "In a merchant cash advance, there is no due date, there is no fixed payment."

Room for Growth

Observers see plenty of room for growth in the merchant cash advance industry. Advance providers have penetrated just 10% of a market potentially worth $5 billion to $10 billion in outstanding advances, says Marc Abbey, managing partner at consulting firm First Annapolis, who has researched the industry. Most business owners who use merchant cash advances would prefer conventional credit, Abbey says. But if they're unable to borrow, some swallow hard and take the high-cost advances.

Tony Boulton, owner of the three-person kitchen supply store Design & Grace in Grapevine, Tex., got $20,000 from AdvanceMe in 2007, which cost him $27,000 in credit-card sales. He renewed for the same terms when his first advance was paid for, because he needed the money for working capital. Boulton says he'd rather have a bank line of credit, but he's been repeatedly turned down. "It's the only way that I've found of getting funds that I need," he says. "The sooner I can get out of it, the better. But right now it's the only option I have."

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