If you’re starting a small business, or own a business but have run into some money trouble, you might be tempted to take out a merchant cash advance (MCA). Sure, these are a quick way to get funding in an emergency, but they’re a terrible idea for business owners. I would never recommend going into debt, especially through an MCA lender, to finance a business—no matter what kind of sticky situation you might find yourself in.
But first, what is a merchant cash advance? Merchant cash advances, otherwise known as business payday loans, are a type of immediate lender financing. They’re a risky option that small-business owners can use in a bind to cover urgent expenses. If cash flow is tight, these cash advances are a relatively easy way to borrow funds. But they come at a huge cost to the business owner, both financially and legally.
The big problem with MCA lenders is that these nontraditional organizations prey on small-business owners and trap them in a cycle of risky repayment plans. But unlike other legitimate options (like tapping into an all-cash business emergency fund or even taking out a small-business loan from a federally regulated credit union), merchant cash advances are super shady and expensive. Even worse, they’re not federally regulated, meaning there’s a major risk you’ll be taken advantage of without any legal consequence for the lender.
Now, let me be clear. Outside of a mortgage on your primary home, I don’t believe in borrowing money for any reason, ever. But when it comes to your business (which you probably started because you want to be independent and grow wealth), signing up for a merchant cash advance when you need help with a financial challenge is a sure way to dig yourself into an even deeper hole than the one you’re in.
First off, MCAs aren’t traditional business loans, so they don’t have to follow lending laws that protect you as a borrower or business owner. This means lenders can charge outrageous fees and follow their own repayment schedule without the government telling them no.
Next, by taking out an MCA, you’re essentially securing the advance with future business revenue. This means you repay the lender directly from your business income, which they can access straight from your business banking accounts. (That detail is conveniently hidden in the fine print of their confusing contracts.) Not to mention, MCAs are one of the easiest and quickest ways to get funding due to their application process. Such a low barrier to borrow lots of money makes it easier to charge you higher fees. This spells doom for a business that’s already struggling.
If you’re not already convinced these are a bad idea, here are some more details about how merchant cash advances work:
The business owner applies for an advance from the lending company. After a speedy approval, the borrowed funds are deposited into your business banking account. Sounds normal so far, until the fees kick in …Instead of charging you interest, MCAs tack on a factor rate that gets multiplied by the entire loan amount. So, a $10,000 advance with a factor rate of 1.4 would cost you $11,400 — not to mention other costs like underwriting fees, admin fees and origination fees.You’re stuck repaying the MCA based on future sales on a daily, weekly or other determined basis. Once you pay off the borrowed amount plus the factor rate and fees, you’re in the clear.
Now, here’s another sneaky drawback. MCAs typically have two repayment options: either a percentage of future sales or a fixed payment over a short period (typically under 18 months). But because the fees are fixed, there’s no way to save money on interest if you pay down the loan earlier than expected, unlike with a traditional small-business loan. You’re locked into those fees for good, no matter how much or how quickly you pay down the loan.
Here’s a much better alternative to predatory merchant cash advances: Start (and run) your business with cash. Save up an emergency fund for your business. Manage every dollar coming into your business and every dollar going out with a detailed budget. This will reduce your risk and increase your peace, even if it means waiting a few extra months to launch while you save up cash to get started or expand your business.
* George Kamel is a national bestselling author of Breaking Free from Broke and a personal finance expert. Following Ramsey Solutions’ proven money plan, George went from negative net worth to a millionaire in under 10 years. Since 2013, he has served on the Ramsey team, speaking across the country, co-hosting top-ranked Ramsey Network podcasts, like Smart Money Happy Hour and The Ramsey Show. George has been featured on Fox News, Fox Business, and The Iced Coffee Hour, among other networks. On his YouTube channel, George educates and entertains, exposing the financial system designed to keep you broke. His goal is to help people spend less, save more, and avoid money traps so they can live a life with more margin, options and freedom. Follow George on TikTok, Instagram, Facebook, YouTube, and X, or online at georgekamel.com.
Dave Ramsey is an eight-time national bestselling author, personal finance expert, and host of “The Ramsey Show.” He has appeared on “Good Morning America,” “CBS This Morning,” “Today,” Fox News, CNN, Fox Business, and many more. Since 1992, Dave has helped people regain control of their money, build wealth, and enhance their lives. He also serves as CEO of Ramsey Solutions and is the author of numerous books including Baby Steps Millionaires: How Ordinary People Built Extraordinary Wealth–and How You Can Too.
