The Evolution of Cash Advances
Merchant cash advances have changed over time in regard to how they have been funded and the collection process. What has changed mostly is the methodology in how they are funded and the risk involved based on the requirements.
Initially the pure cash advance model was similar to credit card processing. Many companies would only give cash advances to merchants that demonstrated a consistent flow of credit and debit card receipts. The merchant cash advance was repaid through split funding of the merchant's payment processing. Generally the credit card processor paid a certain percentage, typically no more than 10%, of the merchant's credit card processing receipts to the company that gave the cash advance and the balance would be paid to the merchant. A redirection letter was typically used, signed by the merchant and given to the merchant's processor, detailing how the funds should be dispersed.
The documentation involved was quite similar to that which is used in giving a loan to a merchant. The cash advance agreement provided provisions such as personal guarantee and security provisions. The lengthy document was to protect against fraud and ensure that merchant's didn't switch to another payment processor in a few weeks to avoid repayment.
The merchant cash advance was quite similar to loan agreements and several lawsuits were filed as a result. The lawsuits claimed that the cash advances were actually loans in disguise.
In reaction to these lawsuits many companies changed their cash advance agreements. They took out the personal guarantee provisions, shortened the length of agreements, and made the new agreements short, easier to read and stripped of the security provisions. By making these changes the companies could argue that cash advances were not loans in disguise.
The only issue that remained was the reliance for split funding with a third party processor. Without control over the merchant's funds, there would inevitably be risk. Some companies opted to become independent sales organizations to resolve that issue but many simply didn't want to go into that business. Thus automated clearing house (ACH) transactions resolved the issue and changed how the merchant cash advance was processed.
The ability to use ACH transactions to take money out of the merchant's bank account changed everything. The merchant's processor didn't need to be involved, the merchant simply had to consent to the cash advance company periodically taking cash from their bank account. There was still risk involved in that the merchant could change their bank account, but it was seen as a good solution overall. The cash advance company could look at the merchant's credit card receipts on a daily basis and take the correct amount based on a percentage from the merchants' bank account.
This methodology became too labor intensive and eventually some companies decided to estimate the amount that should be taken out weekly or daily and then simply withdraw the estimated amount automatically. The ACH withdrawal method worked so well that the number of merchants that could get a cash advance increased.
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