Merchant Cash Advance: Disadvantages

In the previous article, we have already seen what a merchant cash advance is as well as the benefits that are usually associated with such advances. However, it would be inaccurate to state that there are no disadvantages of merchant cash advances. In fact, there are significant disadvantages to such advances. These disadvantages are the reason that large corporate retailers primarily tend to shy away from availing these loans.

In this article, we will have a closer look at many of these reported disadvantages as well as how they impact the business of retail companies which avail such loans.

1. High Interest Rate: The first and most obvious disadvantage of merchant cash advance is the fact that these advances tend to have a higher interest rate as compared to traditional bank loans. This is because of the fact that traditional bank loans are generally secured by the assets of the borrowing firm. However, this is not the case with merchant cash advances. Such advances are only secured with the future cash flow of the firm. It is for this reason that they are considered to be riskier and as a result, it is common for lenders to ask for a higher interest rate as compared to regular loans.

2. Shorter Repayment Periods: Merchant cash advances do not have a fixed repayment period. The repayment of these loans depends upon the cash flow which the underlying business is able to generate.

   However, on average, merchant cash advances are structured in such a way that their repayment tends to be done in a shorter period of time. This means that there is a greater debt burden on the business till the time that the debt has been repaid.

   Hence, the debt coverage ratio of the business tends to worsen in that time frame which may even cause the business to fall into a debt trap and require more loans in order to meet their cash flow requirements.

3. Interference in Operations: Lenders which provide merchant cash advances have noticed that once the borrowers have received the advance, they tend to change their operations in order to delay repaying the loan.

   For example, it is common for the borrowers to ask for their customers to pay them in cash instead of via a credit card. This is because the merchant has a lien on credit card sales but not cash sales. Hence, it is common for retailers who have taken merchant cash advances to provide a discount for cash payments. Over the years, lenders have observed this trend. It is obvious that they want to avoid this situation and hence have started asking for increased control over the operations of the borrowers.

   Lenders have started imposing terms and conditions which restrict the offers that borrowers can give their customers. It is also common for lenders to restrict the borrowers from using the services of certain credit card payment processors. Many small and medium retail firms that use merchant cash advances find these terms and conditions to be too restrictive.

4. Opaque Terms and Conditions: Merchant cash advances have developed the dubious reputation of having several complex hidden terms and conditions. The contracts which govern the lending can be quite complex and may include several different types of fees and charges which may be applicable in different scenarios.

   Hence, many small and medium retail business find it difficult to understand these terms and conditions. This is considered to be a significant disadvantage of using such advances to obtain funds.

5. Complex Pricing: The pricing of merchant cash advances is not very straightforward either. This is because the repayment of such loans is not time bound. However, the rules for repayment are quite complex.

   It is common for interest rates to be increased if the repayment goes beyond a certain specified number of days. Also, there are a wide variety of charges which may be charged to the borrower at different points of time in different scenarios. It is for this reason that larger and more established retail companies tend to avoid merchant cash advances.

6. Data Privacy: Many retail companies want to maintain the privacy of their data. They do not want their sensitive financial information such as their sales data and cash flow position to be available to third parties. However, when it comes to merchant cash advances, retail companies are compelled to share their daily sales and other financial data with the lender.

   It is possible for the retail company to enter into a non-disclosure agreement with their lender to prevent further sharing of data and to ensure data privacy. However, there are many retail companies which want to avoid taking such loans in order to maintain data privacy.

7. Lack of Regulation: Merchant cash advances do not fall under the category of regular loans. It is for this reason that many government regulations related to loans do not apply to such advances.

   Also, in many parts of the world, government usury laws which restrict the interest rate which can be paid by the borrower also do not apply to them. There are several retail companies which try to steer clear of borrowing loans which are not regulated by the law. This is another significant disadvantage of merchant cash advances.

Hence, it can be said that merchant cash advances have several disadvantages for retail companies. It is important for the companies to evaluate the pros and cons before deciding on whether to avail an advance.

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