Payday Loans for Business Owners: What You Need to Know

Last Updated August 8, 2023

You’ve probably heard of payday loans and want to know if businesses can also benefit from this quick financing option. While a popular alternative financing option, business payday loans come with their own set of challenges. Read on to get a better understanding of what a business payday loan is, its risks, and popular alternatives.

What is a Business Payday Loan?

A payday loan is a consumer lending option that is notorious for being an expensive form of funding. These short-term loans can provide quick financing for an individual, but the amount provided is typically capped at $500, though in some states a consumer can receive up to $1,000 from a payday lender (or even up to $50,000 in Oregon).

While payday loans for business owners do not technically exist, this nickname is given to similar business lending options, including merchant cash advances (MCAs) and automated clearing house (ACH) loans. These business cash advance options provide similar short-term and pricey financing that payday loans offer, but they are sold to businesses, rather than consumers.

What are the Risks of a Business Payday Loan?

Although small business payday loans are just a nickname for business funding options that are similar to traditional payday loans, they carry many of the same risks.

The average interest rate on a payday loan is 391%, making it an incredibly expensive form of consumer financing. Similarly, the annual percentage rate (APR) on merchant cash advances can reach 350%, and according to Nav.com, the APR on an ACH loan can be higher than 200%.

Because business payday loans like MCAs and ACH loans can be easily accessible but costly, it is not difficult to fall into a debt spiral, in which you continue to take on more debt to pay off your previous cash advance loans. With high fees and automatic repayments, this debt cycle is difficult to get out of and can even sink a business.

Business Payday Loan vs. Merchant Cash Advance vs. ACH Loan

We’ve mentioned earlier in this article that business payday loans are a nickname given to cash advance loans like MCAs and ACH loans; however, we have not explained how these business financing options work and why they are similar to payday loans. Read on to understand each funding option.

Merchant Cash Advance

A merchant cash advance, also referred to as an MCA, is a short-term lending option for small business owners. Similar to payday loans, MCAs are easy to qualify for but come with a high price tag.

When you get an MCA, you sell your future credit card earnings in exchange for a cash advance. MCAs are tempting because a business can get approved within 24 hours, and no collateral is required. However, to pay back the cash advance, the MCA provider will deduct a percentage of each credit card transaction (called a holdback rate) on a daily or weekly basis until the advance amount and fees are repaid, leaving business owners with little flexibility to manage cash flow.

Merchant cash advances can be a costly and predatory form of financing, which is why they have been given the nickname of business payday loans. Taking on an MCA can lead to a debt cycle in which a business owner must continue to take on additional financing to meet the expensive MCA payments, leading many borrowers to wonder how to get out of their merchant cash advance.

ACH Loan

An ACH loan is similar to a merchant cash advance with three key differences:

1. Rather than funding a business based on its future credit and debit card sales, an ACH advance lender provides funding based on total future sales.
2. Because funding is based on total future sales, the ACH loan repayments will be automatically withdrawn from the business’ bank account, rather than the payment processor.
3. Finally, rather than repaying based on a holdback rate, an ACH advance is repaid based on a fixed rate.

Like an MCA (and payday loan), an ACH loan can be an expensive form financing that comes with a lot of risk of default and taking on additional debt. There is little flexibility in the repayment structure, and making early payments against these loans does not result in a discounted rate.

Business Payday Loan Alternatives

If you are considering taking out one of the “business payday loan” options listed above but are concerned about the cost and coinciding risks, take a look at the additional small business funding options below that may be a better fit.

Invoice Factoring

An alternative financing solution, invoice factoring provides funding to small and medium-sized businesses based on their unpaid invoices. A business owner looking for funding would sell its outstanding invoices to an factoring company in exchange for a cash advance. The business owner would then receive 80-90% of the invoice value upfront. From there, the factoring company would handle the collections process, and when the invoice is paid, the business owner would receive the remaining invoice value minus a small factoring fee.

One of the perks of invoice factoring is that it has a much easier approval process than traditional financing options, like a line of credit. Because factoring companies heavily considers a business’ customers’ credit histories (rather than the credit of the business itself), invoice factoring is a good option for those with little credit or poor credit.

Who Is It Good For?

• Business owners with cash flow problems due to slow-paying customers
• Those that have bad credit
• Those that need help in the AR collections process

Invoice Financing

Invoice financing, also known as invoice discounting, is often confused with invoice factoring, but there are a few key differences. Rather than purchasing a company’s unpaid invoices, an invoice financing lender would instead provide the business with a loan for which the outstanding receivables would act as collateral. Additionally, the responsibility of collecting unpaid invoices would be on the business that has received funding, rather than on the invoice financing provider. This allows a business owner to maintain confidentiality and keep their clients from knowing that they are working with a lender.

Who Is It Good For?

• Those that want to control the AR collections process
• Business owners that do not want their clients to know that they are working with a lender
• Those that are looking for a slightly lower cost of financing

Business Credit Card

A business credit card can be an excellent option for many types of small and medium-sized businesses that need additional spending mechanisms. However, one of the biggest challenges for many new business owners (and those with bad credit) is finding a business credit card that does not require at least average credit. If you have little or poor credit history, you may need to opt for a secured business credit card, which requires you to put down a cash deposit to borrow against. While this may be difficult for a business that is struggling with cash flow, it can come with the opportunity to build up your credit over time.

Who Is It Good For?

• Well-established businesses with good credit
• Those that want additional perks, such as cash back
• Those with bad credit that do not mind getting a secured business credit card

Microloans

An excellent alternative to traditional loans, microloans provide a smaller amount of money to new and growing businesses. Microloan amounts can vary from lender to lender, but typically the maximum that you can receive from a microloan is $50,000. Additionally, microloans typically limit what you can spend the money on, but again, this varies depending on which lender you go through. For example, the Small Business Administration states that you cannot use one of their microloans to pay down debt or purchase real estate.

Who Is It Good For?

• Entrepreneurs with little to no credit history
• Those that only need a small amount of funding