The butterfly effect is the concept that small causes can have large effects. The theory goes that if a butterfly flapped its wings in one part of the world it could cause a disastrous cyclone in another, hence the name. What it boils down to is the far-reaching consequences that big, small or seemingly insignificant things can have. Without getting too philosophical, this plays out in the decisions we make both in a personal capacity and in a business context. History is full of examples of how both good or bad choices have come at a great cost and had a significant impact.
For example, in 2015 the French state railway SNCF spent $15 billion on a new fleet of trains. But, they didn’t account for the width of the trains in comparison to the station platforms. Turns out the trains were too wide for the 1,300 station platforms across the country. This problem cost them an estimated £36 million to fix.
Or, what about the time Google founders Larry Page and Sergey Brin approached Excite CEO George Bell in 1999, saying they were looking to sell Google for about $1 million. Bell wasn’t keen on the initial offering so the founders lowered it to $750 thousand to try to persuade him to buy. He still wasn’t interested. Today Google is valued at around $365 billion and we’re sure George Bell looks back on that day and wishes he could have a do-over.
But what has this got to do with your business? When it comes to credit, the decisions and choices you make on what type of financing to take out can make or break your business. The reality is that it can either send you into a debt cycle or help your business improve sales, expand and grow. So how do you know if a merchant cash provider is the way to go when it comes to business credit? And how can you make sure you’re making a decision that will positively impact your businesses future?
What is a merchant cash advance?
Simply put, a merchant cash advance is a lump sum of capital you repay from part of your daily or weekly credit card transactions. It is not classified as a loan because you’re given an upfront sum of cash in exchange for a chunk of your future sales. It is also characterized by short-term payments between 6-12 months and requires small, regular payments. This is very different to your traditional lenders that require larger monthly payments over a longer term, and often more attractive.
In the past, merchant cash advances have been used by companies with a high use of credit or debit card sales because the repayment structure often suits that business type. However, over the years merchant cash advance providers have made themselves available to other businesses that don’t rely entirely on credit or debit card sales. The truth is, for small to medium size businesses a merchant cash advance is an alternative to banks and traditional lenders. It’s quicker, easier, unsecured funding that doesn’t require collateral. But is it the better alternative?
How do the fee structures work with a merchant cash advance?
Your repayment can vary based on your ability to repay. The merchant cash advance provider will determine a factor rate based on your risk assessment. The higher the risk factor the higher the fees. The total repayment is typically calculated by multiplying the cash advance by the factor rate. In this case, if you were to take an advance of R50 000 that carries a factor rate of 1.4 the total repayment would be R70 000 including fees.
Typical repayment periods are 6-12 months, but this can land up being repaid a lot quicker or over a longer period depending on how credit card sales are going. The higher the sales the faster you can repay the merchant cash advance, but the faster you pay it off the higher your annual percentage rate.
Merchant cash advances have been known to have the most expensive rates, in comparison to online lenders and short-term loans. They carry annual percentage rates – which is the total cost of the advance, including fees. It is also widely agreed that these costs and the daily repayment schedule can cause serious cash flow problems. In some cases, merchant cash advances can lead to debt cycles that are difficult to get out of. Some companies are often forced to refinance to pay off the first advance, and the cycle just continues with the business always playing catch-up.
Because merchant cash advances aren’t classified as loans their interest rates are not regulated by legislation that limit lenders from charging high interest rates. This technicality allows them to operate in an unregulated market and charge much higher interest rates than most traditional lenders. This is why many businesses consider merchant cash advance financing as a last resort.
Pros and Cons of a merchant cash advance:
It might not be easy to see the downside to a merchant cash advance, especially when it’s quicker than your traditional lenders and doesn’t require any type of collateral. But before you decide to go that route or think it’s your only option, here are some pros and cons to consider:
| Pros | Cons |
|---|---|
| Quicker access to funds than traditional lenders | Extremely high fees |
| Bad credit is acceptable | Less flexibility to charge merchant service providers |
| Suitable for a wide range of business purposes | Daily deductions of credit card receipts reduce cash flow |
| Fluctuates with your business’s daily sales. Pay more when your business does well, pay less when sales are slow. | Not governed by legislation therefore no oversight on interest rates |
| Unsecured | Higher sales equal a higher annual percentage rate/borrowing cost |
| No benefits to repaying early | |
| Debt cycle danger |
Why Lulalend is the better alternative?
Lulalend is South Africa’s only online lender. We take the best parts of a merchant cash advance and offer other benefits too. We accelerate the speed at which you can access funding to 24 hours, we ensure an unmatched experience when it comes to ease of application by making it a completely online experience, requiring no paperwork, and we offer unsecured funding. But we don’t stop there.
Unlike a merchant cash advance where rates vary on a day-to-day based depending on your sales, ours are fixed and there are no hidden fees. In this way you know the exact amount coming off against each debit order. Payments are also made twice a month so that it isn’t one lump sum at the end of each month or daily payments based on unknown sales – which can make cash flow tricky. With Lulalend you can also settle early with no penalty fees, yip you heard right.
So, before turning to a merchant cash advance, small business owners should seek out alternatives. There are many options out there but a merchant cash advance is certainly the more expensive route.
For a quick overview, here’s how we stack up against a merchant cash advance:
| Lulalend | Merchant cash advance | |
|---|---|---|
| Access to funds in 24 hours | ✓ | x |
| Fixed rates, no hidden fees | ✓ | x |
| Repayment schedule makes cash flow more manageable | ✓ | x |
| Suitable for all business types | ✓ | x |
| Suitable for a wide range of business purposes | ✓ | ✓ |
| Unsecured (no collateral required) | ✓ | ✓ |
| No annual percentage rate increase | ✓ | x |
| No early settlement fees | ✓ | x |
| No paperwork required (everything is done online) | ✓ | x |
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