BizSugar.com › Raising Capital › Why you should avoid "merchant cash advances"

While most financial-services firms are floundering, those that specialize in so-called merchant cash advances are thriving. That's a mixed blessing for small business owners who increasingly are turning to these sources for quick cash: Their money can come with a high price tag.

Like regular lenders, merchant cash firms dole out a lump sum. But rather than requiring that borrowers make a fixed payment at a specific interest rate, these companies collect a piece of a merchant's total credit-card sales each month—via the credit-card processing service—until they recoup the total amount plus a premium.

Merchant cash advances have been around for roughly a decade. But with big banks in full retreat from lending, more entrepreneurs are seeking help from the likes of AdvanceMe, AmeriMerchant, and hundreds of other companies and independent contractors that offer such advances.

This type of financing, though, is controversial. Traditional lenders follow state guidelines, known as usury laws, that limit the interest rates they can charge borrowers. Merchant cash advances are defined as the "purchase and sale of future credit-card receivables" rather than an actual loan. That exempts the advances from the usury laws. For example, a merchant cash advance where the firm charges fees of 33% of the principal during a 7-month repayment period is akin to taking out a loan at an annualized interest rate of more than 50%.