Small Business

How to Vet a Merchant Cash Advance Provider


Advance providers say they're doing more to self-regulate, but a merchant's best protection is to understand the terms of the contract before signing up

If you're considering a merchant cash advance for your business, how can you evaluate the provider? Even the largest providers, who say cash advances have gotten a bad rap, concede that some companies or independent brokers have been too eager to sign up merchants who aren't a good fit for the product. Cash advances remain a niche product, but some analysts say the industry is growing by double digits and could reach $10 billion in advances. Business owners should understand the risks before signing up.

Advance providers offer small business owners up-front payments in exchange for the right to collect a portion of their future credit-card sales. The quick, unsecured funds come at a high price: providers typically charge premiums of 30% or more of the amount advanced and collect it in a matter of months. They usually sell to retail, restaurant, and service companies with high credit-card volume, and because the advances get paid off as a set percentage of credit-card sales, merchants repay less in slow months—a flexibility providers say is a key selling point. Cash advance providers say they offer capital to companies that banks won't lend to, and that advances are expensive compared to loans because they assume the risk that a business may go under or not repay as quickly as expected.

Tougher Lending Standards May Curb Abuses

Or at least that's how it's supposed to work. Some complaints filed with the Federal Trade Commission in the last two years tell a different story. One business owner, whose name was redacted from a complaint he filed, took out a cash advance in 2007 but had to close his business in February 2008. A collector told him that "he would come after my home, cars, furniture, and whatever else he could to recoup their money," according to the complaint. Another complaint, filed in April, said the advance provider began collecting $300 a week when sales slowed down, even though that was more than the agreed-upon rate. The same complaint said the provider took cash directly out of his business checking account. Other complaints filed with the FTC make similar allegations and some show sales agents calling constantly—as often as seven times a day.

To be sure, the number of complaints is tiny compared to the number of merchant cash advance transactions. Cash advance providers say most customers are satisfied, with many renewing after the initial advance is paid off. Industry insiders say the financial crisis curbed some of the most aggressive practices, as advance providers become more selective about who they fund. "You had all these companies coming out like wild cowboys giving money to anybody who had a pulse," says David Goldin, chief executive officer of New York-based advance provider AmeriMerchant, one of a handful of large industry players. But in recent months, he says, companies have raised underwriting standards, lowered the amounts they're willing to advance, and in some cases dropped their approval rates from 80% to 20%.

Get a Contract Before Your Borrow

Companies exploring merchant cash advances should first determine whether they're dealing with a broker or an actual advance provider by asking for a copy of the contract, not just the application, Goldin says. The contract will have the name of the actual provider and spell out the terms of the advance. Business owners should also find out how long providers have been in business and ask to talk to customer references.

The cash advance industry has been taking steps toward self-regulation. Last year about a dozen companies formed a trade association, the North American Merchant Advance Association, but even many of those firms have been the subject of FTC complaints. Still, merchant cash advance providers may be able to root out abusive tactics on their own, says Reilly Dolan, assistant director for financial practices at FTC. "There are models where self-regulatory actions have teeth," he says, such as the Better Business Bureau's National Advertising Division.

But right now, merchants have to vet cash advance providers on their own, because once they sign a contract they have little recourse if things turn sour. Cash advances are not covered by lending laws because they are structured as sales of future income. Business-to-business transactions are exempt from federal consumer protection laws like the Truth in Lending Act, the Electronic Funds Transfer Act, and the Fair Debt Collection Practices Act, says the FTC's Dolan. The commission does have broad authority to investigate "unfair or deceptive acts or practices," so business owners can still file complaints on the FTC's Web site or over the phone at 877-FTC-HELP. The commission uses its complaint database to spot trends and target law enforcement actions.

Merchant cash advance companies hope that their own steps to rein in bad practices will make that unnecessary. Says Goldin, "the funding companies at this point are large enough that they are concerned about reputation."

Tozzi covers small business for BusinessWeek.com.

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