Running a business is a very expensive affair, and many times, the old saying, ‘you need money to make more’, applies.
Whether it’s money to cover fixed expenses, emergencies, or unforeseen expenses, many businesses need financial help once in a while.
Therefore, every business owner needs to look for various financing options to manage the challenges of cash flow. One good option is the merchant cash advance.
What is a merchant cash advance?
Merchant cash advance is a form of quick funding that allows a third-party lender or credit card processor to advance money to a business based on their credit card volumes. It means the lender purchases a certain slice of your business’s future sales.
Merchant cash advances work best for those businesses that process and use credit/debit cards for their payments.
Advantages of merchant cash advances
The biggest worry for any business under financial distress is getting quick funding, and merchant cash provides a good option. Some lenders can deliver the needed capital 48-72hours after the completion of the online application.
Since merchant cash advances are unsecured, they don’t require physical collateral to back up the financing. Therefore, you don’t have to worry about losing your business assets if you don’t manage to repay.
However, the lender may require a personal guarantee through a written agreement, which makes you (borrower) take personal responsibility for repaying the advance.
No bulky paperwork
Since every application is done online, the amount of paperwork needed is minimal or even none, for some lenders. Therefore, this decreases the waiting time.
As time goes by, repayment of merchant cash advances becomes easier since the payments are based on your sales percentage, instead of a fixed monthly payment.
So, for instance, in case your sales are low, you don’t have to repay much. This may favor businesses with fluctuating sales, especially businesses that depend on seasonal sales.
High approval rates
This is great news, especially for those struggling small businesses that may need a quick cash advance or have been turned down by other traditional lenders.
No need for a perfect credit score
Companies that provide these advances don’t need a perfect credit score, so most businesses can still access financing.
The disadvantages of merchant cash advances
Potential cash-flow problems
The biggest risk of taking merchant cash advances is that it allocates your future sales towards advance repayment of the loan. This may result in further cash flow problems, incurring more debt and repeating the borrowing cycle.
Unlike traditional loans, merchant cash advances attract higher costs. These costs are described in terms of factor rates rather than interest rates.
Factor rates, unlike interest rates, aren’t based on any particular period. Therefore, paying off your advance fast doesn’t mean saving money. You have to repay the entire factor rate.
Merchant cash advances are unregulated, meaning, they control their factor rates and terms. This can potentially expose businesses to exploitation.
How merchant cash advances work
A merchant cash advance starts with the borrower signing an agreement/contract with the lender.
The contracts include the applicable fees and repayment collection methods. However, it does not include a fixed repayment date since the advance becomes fully paid once the predefined interest and principle are fully collected.
What is in a merchant cash advance contract?
This is the lump sum amount the borrower will receive once the advance is approved. The advance funding amount depends on the business’s financial strength.
This is the amount that the business owner needs to repay, and it’s calculated based on the factoring fee and the amount funded.
Holdback is the agreed-upon daily credit receipts (calculated in percentage form) that are withheld by the business to repay the merchant cash advance.
Repaying the merchant cash advance
Since a merchant cash advance is not a traditional loan, the advance depends on your credit card volume. Most lenders recover their advances from your daily/weekly credit card transactions.
If your lender requires daily payments, the repayment starts the next day after the disbursement of the funds and there is no grace period.Additionally, the borrower must hold back a certain percentage of their daily card transactions, and this amount is debited directly from the account.
The holdback percentages range between 5%-20%, and it remains a fixed amount until you repay the advance fully.
For example, if you borrow $10,000 using a factor rate of 1.5-factor rate, you will repay $5000, so the total borrowed capital becomes $15,000. So, if the holdback percentage is 10% and your merchant account receives a deposit of $5000 today, you would hold back $500.
The holdback amount varies depending on your daily credit card receipts. In other words, when you receive a huge credit card receipt, you will hold back a larger amount than the days you have fewer sales.
Therefore, it is advisable to confirm whether the periodic payment is done daily or weekly to help you manage your cash flow effectively.
Is a merchant cash advance the best deal for your business?
Well, a merchant cash advance acts as a tool to quickly access capital, but it can also put your business cash flow into jeopardy, if not properly managed. Although many factors make merchant cash advances attractive, its ideal only as a short-term cash flow opportunity to enable the business to generate the best ROI with a quick-turnaround inventory.
What happens if a business owner defaults on their merchant cash advance?
Most lender’s contracts include the borrower’s personal guarantee, and therefore, incase of default, the lender will pursue your personal assets to recoup their advance. Additionally, they may also report the default, blocking you from accessing financing in the future.
Well, proceed with caution! A merchant cash advance is good when you need quick cash, or in case you can’t qualify for any other financing. However, you can leverage a merchant cash advance to take your business to the next level.