Merchant Cash Advance Regulation: Does It Exist? What You Need to Know

If you’re a small business owner looking for quick business loans with little hassle, then a merchant cash advance probably looks like a pretty good deal to you. Online applications, same-day business funding, and little documentation needed? Sounds just like what you need. But before you act on applying for a merchant cash advance, proceed with caution: Merchant cash advances are the most expensive financing option on the market.

Their steep costs paired with the qualification ease has recently put merchant cash advances under scrutiny. Is there merchant cash advance regulation? Why would merchant cash advances need to be regulated in the first place? We’ll walk through the state of merchant cash advance regulation in this complete guide.

Let’s cover the basics of a merchant cash advance. A merchant cash advance is unlike other business loans—in fact, it isn’t technically a loan.

A merchant cash advance is, well, an advance. In this type of financing, a merchant cash advance company or provider advances you an upfront sum of cash in exchange for a slice of your future credit and debit card sales. Because the company is purchasing your future credit card sales, a merchant cash advance isn’t a loan.

When you go into a merchant cash advance agreement, you’ll settle on a fixed percentage that the merchant cash advance company will take from your credit and debit card sales every day (or sometimes every week). The merchant cash advance company will continue to take this fixed percentage—plus fees—until the advance is paid in full.

In most scenarios, you get quoted a factor rate with your merchant cash advance. Unlike an interest rate, a factor rate is in decimal form. The typical factor rate for a merchant cash advance ranges from 1.2 to 1.5.

When you get quoted a factor rate, be sure to multiply the factor rate by the total advance amount—that tells you the total amount that you need to repay the merchant cash advance company. The factor rate you’re quoted on your merchant cash advance offer varies based on your risk assessment. If the merchant cash advance provider has reason to believe that you’ll probably be bringing in enough credit card sales to repay the merchant cash advance in full, then you might see a factor rate on the lower end of the aforementioned scale.

However, if you’re a riskier merchant—with a lower credit score, or more volatile credit card sales and revenue—you could be quoted a steep factor rate. This gives the merchant cash advance provider assurance that they’ll get most of their money back even if you default on the advance repayments. In the end, the riskier you are to work with, the higher the factor rate you’ll get. And a higher factor rate means you’ll pay more in fees.

Now that you’ve got the general gist of how a merchant cash advance, let’s look at an example of a merchant cash advance. Say you run a coffee shop, and you need an infusion of about $20,000 of capital. You don’t have time to wait around for approval from a bank or longer-term lender, and plus, you probably can’t qualify for one anyway.

Your credit history, time in business, and annual revenue just isn’t there. So you turn to a merchant cash advance provider for that $20,000. You’re approved for a $20,000 merchant cash advance, with a factor rate of 1.35. All in, you’ll need to pay $7,000 for a total of $27,000.

However, when you consider how quickly you need to repay your merchant cash advance, you’ll realize how expensive they can be. Say that the merchant cash advance provider plans to take 15% of your daily credit card sales, and that you usually bring in about $10,000 a month in credit card sales. This means that you’ll make 216 daily payments of about $125 each day. All in, that’s an effective APR of 106.66%—making the merchant cash advance look more expensive than it originally seemed.

There are without a doubt benefits to this type of small business financing. If you don’t qualify for any other loan options and you need quick capital, a merchant cash advance might be your only option. And if getting capital for your business is a make-or-break situation for your future, then you’ll be happy that a merchant cash advance is available to you.

However, there are lots of reasons why small business owners should approach merchant cash advances carefully—and why people are calling for merchant cash advance regulation (we’ll get to that in a minute).^[1] Here are some dangers of a merchant cash advance:

Those are just a few of the reasons why you should watch out for merchant cash advances.

The amount of red flags that come with merchant cash advances bodes the question: Is there merchant cash advance regulation? The answer is, there really isn’t merchant cash advance regulation. Here’s what it comes down to.

Remember how we said that merchant cash advance companies purchase your future credit card sales? A merchant cash advance isn’t a loan—it’s a sale. And because it’s not a loan, merchant cash advance companies aren’t subject to the same federal regulatory oversight other lenders are.

Other lenders are bound by state usury laws that inhibit them from charging high-interest rates.^[2] In 2016, a New York State Judge ruled that as long as a merchant cash advance is definitely not a loan, then merchant cash advance companies aren’t subject to usury laws.^[3] The fact that merchant cash advance companies technically aren’t “lenders” is a technicality that allows these providers to operate in a largely unregulated market—and charge steep interest rates.

Technically, merchant cash advance regulation comes from the Uniform Commercial Code in each state.^[4] But because they aren’t subject to usury laws or the Truth in Lending Act, merchant cash advance companies can charge much higher interest rates than other small business lenders, and they don’t have to prevent their costs in the same way—making it confusing for borrowers to distinguish the true cost of the advance.

As alternative lending becomes more popular, all online, non-bank lenders will be put under scrutiny. Merchant cash advance companies are starting to be looked at with an especially critical eye.^[1] But are we moving closer to merchant cash advance regulation? In terms of how much merchant cash advance companies can charge in interest, no. As long as a merchant cash advance is still a purchase of receivables—and not a loan—these companies won’t be subject to usury laws that prevent lenders from charging interest rates.

There’s hope that the industry is moving toward self-regulation, however. Although this is more of a tactic to avoid future federal regulation, it could be steps in the right direction. This self-regulation could entail mandatory documentation of training on how to sell these products—and present their cost in a transparent way. Generally, it’s clear that some type of government regulation will need to step in to oversee the online lending space.^[1] But it’s not clear if that regulation will be merchant cash advance regulation.

Likely, it will be regulation of online small business lenders, which still might not affect merchant cash advance companies. If merchant cash advance regulation happens in the future, it will likely be to require industry-wide rate disclosure, rate limitation, and other measures to prevent predatory lending. This will not only protect small business owners who can’t afford to take on such expensive debt, but also help legitimize the small business lending industry as a whole.

Without merchant cash advance regulation, you need to approach these financing products with absolute caution. If they’re really your only financing option, then you need to make sure you’re taking steps to protect yourself when pursuing these advances. Without merchant cash advance regulation, be sure to:

Without merchant cash advance regulation, you need to protect yourself by being a smart shopper. Another way to avoid taking on debt that’s too expensive is to do your homework: Is a merchant cash advance really your only option? You won’t know that you really need to take on a merchant cash advance until you’ve fully compared all your other lending options.

That way, you can be confident that you wouldn’t find lower rates with a different product or a different lender. And when it comes down to it, there are other financing options for business owners who need fast cash or don’t qualify for other financing options. If that’s you, two good lending options to check out are short-term loans and shorter-term lines of credit.

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While there’s no substantial merchant cash advance regulation protecting borrowers just yet, there are steps you can take to be cautious. In the end, don’t rush into a product if you aren’t confident you’ll be able to pay it back. Even if you need financing today, or don’t qualify for anything else, you need to take the steps to put your own merchant cash advance regulation in place!

1. AmericanBanker.com. “Time for Online Lenders to Get Serious About Regulations“
2. Wikipedia.com. “Merchant Cash Advance“
3. Debanked.com. “Merchant Cash Advance Definitely NOT a Loan, New York Judge Rules“
4. FirstData.com. “How Merchant Cash Advances Can Boost Retention and Profits“